Sometimes, families and friends can
even be your only source of funds. If you have bad credit, have no
collateral or equity investment to put in your business, or if you have no
experience in the business, banks will consider you too high risk and there
is little chance you can fund your business through loans.
However, borrowing from your kin is not without problems. In fact, in
many respects, it is even more difficult than getting a loan from a bank.
Experts even advice that you should think twice in involving your family in
the startup of your business.
Here are some steps to prevent unwanted problems when borrowing from
families and friends:
1. Choose the right person.
Start with the right person to borrow from.
You know the characters and personalities of your family members and
friends, and the wrong person can force you to spend a lot of time and give
you loads of stress. Some may not live down the fact that you borrowed money
from them. Worse, they may act as if they own you and your business.
2. Understand that this is high risk capital.
Borrowing from family and
friends entails the highest risk. Unlike banks or venture capitalists where
your relationship is purely business, your personal relationship with the
family member or friend is on the line (and can be jeopardized!) when you
borrow from them. Think how you will face your father-in-law at the dinner
table when you lost all his money. Or consider whether you are ready to
throw out your relationship with your best friend since kindergarten.
Personal relationships can be destroyed with the parties not speaking to
each other ever again when bad investments happen.
3. Ask for money only when you are prepared and ready.
If you have an
idea for a business that you think could work, do not immediately present
the idea to your family and friends and ask to borrow money without doing
research on the viability of the business. It is easy to get excited about
eureka moments in business when you think you have stumbled upon the next
great business.
Your relationship with your family and friend can better survive a
business involvement if you present to them both the opportunities and risks
involved in investing in your business. Nothing ruins a relationship faster
than providing false promises on the basis that they can double or triple
their money when they invest in your business. Treat your family and friends
as you would a banker or an angel investor: do your research, prepare your
business plan, and show how exactly the business is going to make money, do
some number crunching and prepare your financials. With your research and
business plan on hand, they can get into the business fully aware of
potential gains and losses; and you show to them that you value and respect
their investment.
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4. Discuss how their investment will be structured.
You can choose to
consider their investment as equity where they will share ownership of the
business. Or you can consider their money as debt that you will repay after
a pre-agreed period of time with appropriate interest.
How the borrowed money is handled is an issue that needs to be on the
table before any money is exchanged. If you are not ready to give up
ownership but your family member or friend expects to be part-owner of the
business, then you need to straighten this out with them. The worst thing
that can happen if for relatives and friends acting as if they own the
business and make decisions for you.
If this is a debt, consider paying interest (though it sure can be so
tempting to get the money interest free, after all, this is your beloved
Uncle or Aunt). If you do not pay interest, you may be faced with tax
implications. The IRS may consider no-interest loans among family members,
including loans made below market rates, or at no-interest, subject to
federal gift tax. Consult your accountant on the implications of this type
of money.
5. Put everything in writing.
They may be your family and friends, but if
we’re talking about money, is it best to keep everything in writing for both
your protection. Handshakes are never enough. Having a contract or a
document specifying the terms and conditions of the investment will help
ensure that the agreement stays professional.
Plus, if the loan is formalized, the lender may be entitled to a tax
deduction as “bad debt” in the event that the business fell apart and you
cannot pay the loan. That can give your source of funds more confidence in
giving you the money you need.
About the Author:
George Rodriguez is a staff writer of PowerHomeBiz.com. For a step-by-step
information on starting a business, order the
"Checklist for Starting a
Business" ebook now.
Copyright 2006 PowerHomebiz.com, LLC
November 2006
