Small Business Loans From Friends and Family
Friends and family remains one of the most likely places small business owners can find success looking for capital. This is true for established businesses as well as new businesses. Nevertheless, borrowing from a successful college roommate, a wealthy uncle, or your dad can backfire if you aren’t careful.
While your family and friends are often some of your biggest supporters, take a more formal approach to borrowing from friends and family:
- Debt or Equity? There is more than one way to structure the transaction. A loan is not the only way. You might also decide to treat capital raised from family or friends as an equity investment. It means your family member or friend will be investing in your business in the same way an angel investor or venture capitalist might. While you don’t make regular loan payments to an investor, in exchange for their capital they receive a percentage of equity in your business that will return a profit at some point in the future—perhaps once the business is profitable, or when the business sells or recognizes some other liquidity event.
- Treat it like you would any other financial transaction: If you decide to structure it as a loan, plan on making regular and timely payments—even if your friend or family member initially suggests you don’t need to (which they probably will). Making regular payments right from the start lets them know you appreciate their help and don’t intend to take them for granted.
- Ask for what you need, no more: I’m convinced the worst answer to “How much do you need?” is “How much can I get?” This is particularly true when talking to family. Be prepared to explain exactly how much money you need, what you need the money for, and the value it will add to your business.
- Put it in writing: Capture any agreed-upon terms on paper, preferably in a formal document that spells out how much you’re borrowing, what the payment terms are, and any interest (if applicable). An Internet search may help you identify an appropriate adviser or online service that can help you structure an agreement for your particular situation.
- Keep the agreed-upon terms: Although this might sound obvious, if you commit to making a payment at the first of every month, make the payment. Treat your family member or your friend the same way you would any other creditor. If your dad suggests you defer making payments “until you start making money,” you should define what that is. His definition could be different from yours.
- Be prepared to take a little advice along with the loan: Don’t be surprised if your dad, or Uncle Fred, wants to give you business advice—it’s their cash at stake now too, after all.
- Be open: Make sure you keep the lines of communication open and establish an honest business relationship with your family lender. Don’t be surprised if they wonder why you haven’t made the last loan payment to them if you pull up to the next family party in a new car.
Don’t be casual with the transaction. An informal exchange might feel more natural, but can lead to negative outcomes should questions or problems arise down the road.
Loans from friends and family are sometimes called 3-F loans (friends, family, and fools) for a reason. Many business owners borrow from family or friends with every good intention of making repayment, but those obligations often get set aside for what might be perceived as “real” business obligations. Borrowing from friends and family adds a level of complexity to business financing that doesn’t exist with other loans. Treat these loans (or investments) as real obligations too, because they are.
Learn more about business loans from friends and family.
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