Rayanne Thorn: Jobseekers: Understanding the Candidate Experience
LOOK: Mystery Man Gives Canada Animal Shelter $25,000 In Random Act…
Borrowing from Friends and Family: 5 Things You Need to Know
Friends and family are the most common source of startup capital. But such loans are not without risk. How to ensure your financial relationship doesn't jeopardize your personal one.
Posted 7/ 19 10 at 4:30 PM | 5 Things You Need to Know, Money, Leadership, Starting a Business, Home-based Business, Taxes & Accounting, Legal Issues
Text Size:
A A A
For a lot of startups, money is tough to come by. So it's not surprising that many fledgling entrepreneurs think about borrowing from the Bank of Mom and Dad or floating their business plans by college buddies. In fact, borrowing money from friends and family is the most common method for raising startup capital.But getting a business loan from your friends and family can't help but become personal -- and there are countless horror stories out there to prove it. That said, there are also plenty of successful entrepreneurial stories that begin with conversations at the Thanksgiving table or the local bar. How can you approach this tricky topic and ensure that your personal relationships do not suffer? Here are five things you need to know.
1
Money will impact your relationships.
Not that you haven't considered that. But it's worth really thinking this through. If you can't pay back the money your friends or family loan you, or if you take it and then don't communicate with them, you could lose your relationship. And while you may be right if you're thinking, "Mom would never disown me," or, "Chuck and I have been friends since third grade," the respect they have for you could take a hit. "Make sure that this loan doesn't put the family member or friend in a hardship," urges Lisa Baskfield, a member of the American Institute of Certified Public Accounts' National CPA Financial Literary Commission. "It's similar to investing in the market. The person loaning the money should be okay with the idea of losing all funds."
2
Treat this as a business relationship.
Jeffrey L. Yount's advice seems right on the mark. "Treat this transaction as a normal business transaction," advises Yount, a partner at B2B CFO, which provides CFO services for emerging and mid-market companies. "That's what it is. Don't have an attitude that implies, 'These are my friends and family. They will understand if I miss or delay a monthly payment, or fail to provide timely financial information or fail to communicate financial issues.'" At the same time, Yount says, "This is your business. Don't let the friends and family interfere with the day-to-day operations. Remember, they have only provided some financing -- they are not co-owners."
3
If the loan is more than $10,000, enlist an accountant.
Mitchell Freedman, who owns the Mitchell Freedman Accountancy Corporation in Westlake Village, Calif., correctly observes that many family and friends don't want to charge borrower interest to their relative or pal who is starting up a business. But they may have to. "If the loan is for more than $10,000, the lender is required by tax law to charge interest on the loan, even if her or she doesn't want to," Freedman says. "If there is no interest, then OID [Original Issue Discount] effectively reduces the amount of the loan and requires the lender to pick up a portion of the repayment as interest income. The IRS issues monthly minimum interest rates that must be charged, called AFR [Applicable Federal Rate]." In other words, if the loan is more than $10,000, thank your friend or family member profusely -- and then consult a tax accountant or attorney.
4
Put everything in writing.
That may sound obvious, but we would be remiss if we didn't stress it. All of the terms -- how much the loan is, when it's going to be paid back, what the interest rate will be if there is one -- should be put down on paper. Freedman adds that if there's any collateral you plan on giving your friends and family if the loan isn't paid back, put that down, too.
Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling, suggests explaining what will happen to the loan if you die. "Will the loan be forgiven, or will it still be owed?" she asks.
Now, of course, if we're just talking a loan for a few hundred dollars, the stakes aren't as high. Plus, these are your friends and family we're talking about. Chances are, if you somehow perish before your company is moving along, and you leave some friends and family in the financial lurch, they won't shake down your spouse, kids or elderly parents for the rest of what you owe them. On the other hand, you never know. The more money you borrow, the more of these questions you should ask.
Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling, suggests explaining what will happen to the loan if you die. "Will the loan be forgiven, or will it still be owed?" she asks.
Now, of course, if we're just talking a loan for a few hundred dollars, the stakes aren't as high. Plus, these are your friends and family we're talking about. Chances are, if you somehow perish before your company is moving along, and you leave some friends and family in the financial lurch, they won't shake down your spouse, kids or elderly parents for the rest of what you owe them. On the other hand, you never know. The more money you borrow, the more of these questions you should ask.
5
Be realistic.
Baskfield urges realism on payment terms and warns, "Don't make false promises." Because they're your friends and family, you may feel the urge to dazzle them with suggestions that they're all going to become rich, fast. But starting a business can be extremely challenging, and this is a tough economy. When you're borrowing from friends and family, if you can, under-promise and over-deliver. But above all, when structuring your repayments, pad in some extra time for unexpected problems -- like having your own clients or vendors dragging their feet in paying you back.
Geoff Williams is a regular contributor to AOL Small Business. He is also the co-author of the book Living Well with Bad Credit.
Geoff Williams is a regular contributor to AOL Small Business. He is also the co-author of the book Living Well with Bad Credit.
Getty Images
- 'Marriage Penalty' Could Make Costly Return - CNNMoney
- Oil Rises on Optimism for Cliff Deal - FOXBusiness
- Dow 2012: The Studs and Duds - InvestorPlace
- Turning the Corner: Why 2012 Wasn't as Bad as You Think - The Motley Fool
- World’s Longest High-Speed Rail Line Unveiled In China - IBTimes
- FORGET THE DEFICIT: Here's The Real Reason Liberals Want To Hike Taxes On The Rich - Business Insider
- CEOs to Fire in 2013 - 24/7 Wall St.
- DailyFinance Market Minute - DailyFinance
Comments (Page 1 of 1)
Keep in mind that family, and some friends, knew you when you were a silly kid with barely enough sense to sell lemonade on the street corner. So when you come to them, asking for money, they try not to laugh. Even more so, you are asking for sizable sums that give them reason for pause.
But because they are family, they would rather make lame excuses than tell you the truth that
they don't think you've developed skills for business success. Accordingly, your task is to convince them that you're not the same kid and you've grown up into a mature adult. What's more show them that you’ve developed the skills along the way to safeguard their money and return it with dividends or interest.
The way you convince them this with a dynamite business plan depicting your skills, accomplishments and the ability to repay their generosity in monetary terms. It is similar to making the loan request with an institutional lender.
Go for it and never give. If become an entrepreneur were easy, everyone would be one.
Jerry
Jerry Chautin
Business columnist
Volunteer SCORE business counselor, Atlanta, Sarasota & Murphy, NC
Former entrepreneur, commercial mortgage banker, business lender
Follow me on www.Twitter.com/JerryChautin
http://tenonline.org/sref/jc1bio.html
My niece has a ploy -- or did. She came over to help me clean up one day, and suddenly, out of the clear blue sky, said: "....Can I haave five hundred D.O.L.L.A.R.S.?" in a sweet, little girl voice. I had the money and gave it to her, (stupidly), feeling as if my life was not worth anything, because I'm over 30 years older than she is. I wondered if she'd ask again....and if so, how much? $500 again? $600? $700? $1000? Well, she did ask again. "....Can I have $1500 D.O.L.L.A.R.S.?"
This time I said NO! (When I asked her mom to ask her to pay back the $500, my sister said, "...Well, if you don't want top help this family...!" Both my sister and my neice know that, (unlike my niece), I am handicapped, do not have a job, and am living on what my parents left me. Plus, my medicine costs $3000 a year! Well, my sister knows these things anyway. My neice has NOT asked me for money again, and I feel a fool giving her the $500. Live and learn. (When I send out e-mails to the rest of my friends and family, I always send out a SEPARATE one for her. Because I don't want her to go asking OTHER relatives, and my friends, for money -- as she very well might! I recent5ly found a wonderful book, "When I Say No, I Feel Guilty". Wish I'd had that before she asked the first time.
Remember Shakespeare..."Neither a borrower nor a lender be, for loan oft loses both itself and friend; and borrowing dulls the edge of husbandry." (Hamlet Act I, Scene 3). That really says it all. Most relatives come to you with hat in hand. Many become insulted if you question them too deeply as to how you will be repaid. A true friend rarely puts you in the position of having to refuse them. Many people make friends in order to have someone to use. The best bet is to say no unless you know they
are into a venture that will generate a return. Even then, as the article states, have then sign a legal document. Lending money is business and exists outside the realm of relationships with relatives and friends.