Getting funding is very hard when you start a business. Banks typically aren’t interested, and other financing options often aren’t available until you’re more established. Bootstrapping isn’t an option for every startup – in some cases you do need some funds to get going.
One great source of support can be family members. They know your background and what you are capable of. They’re more likely to offer flexible repayment terms, giving you more time to get your venture off the ground. Relatives may also be happy to offer lower interest rates than a bank would.
But how should you go about arranging a loan or investment from a relative, and what happens if things go south? Here are some dos and don’ts to consider before accepting money from loved ones.
DO Get Professional Legal Advice
It’s impossible to overemphasise how critical it is to have a proper legal agreement drawn up first. You should always consult your lawyer and your own accountant before entering any kind of financial or business transaction that exposes you and/or the other party to financial risk. This also makes it much easier to discuss terms in a neutral, businesslike way. Families can fracture permanently over financial disputes.
DO Provide Full Details
Your relative deserves a clear picture of what your business plan is, why you need the money and how you plan to spend it. You should be clear about the expectations of when your business will become profitable enough to repay its debts in full. Any commercial lender would demand a proper business plan.
DO Document Everything
Just because your parents aren’t an actual bank doesn’t mean things should be handled any less professionally. The loan paperwork should detail the amount borrowed, the interest rate and the required payment terms. All repayments should be recorded properly, with receipts given. Your business accounting software can be a great way to track this.
DO Make Regular Payments
Pay off the loan early if you can. This proves that you make an effort to meet your obligations, and it may mean the same relative or other family members are prepared to loan to you in future.
DON’T Borrow What You Can’t Repay
Ultimately when you lend to and borrow from loved ones, it’s about trust. If you know from the outset that you’re unlikely to be able to repay them, you’re breaching that trust. It also means your business may need a rethink if it’s not going to be profitable or even stable within a specific time period.
DON’T Borrow from People Who Can’t Afford It
This is particularly important if you know your venture is risky. If lending you the money means someone could lose their house or face straitened financial circumstances if you default, don’t accept a loan from them. Individuals aren’t banks – they don’t have the same capacity to absorb bad debt. Always consider the impact the loan will have on the lender.
DON’T Accept Meddling
Make it clear that this is a business transaction, not a partnership or joint venture. It’s your vision, and you are the one in charge of operations and strategic decisions. At the same time, if you are borrowing from someone who is a successful entrepreneur or business professional themselves, it may be worth getting their take on your own business.
DON’T Go Silent
If your business is struggling or things are behind schedule, it’s better to maintain communication with your lenders and see if you can adjust the repayment schedule.
Remember that interest on loans from family or friends is taxable – they need to declare any interest received as income. Likewise you can deduct the interest as a legitimate business expense.
You should also encourage family members to see a financial counsellor themselves. Centrelink’s Financial Information Service can provide free initial advice on financial issues. While you want to start your business with optimism, it’s important that everyone considers the worst-case scenario and what would happen if the business failed.
This information is factual only and is not intended to to imply any recommendation about any financial products or constitute advice. You are responsible for consulting with your own professional tax advisors and financial advisors concerning specific tax or financial circumstances for your business. Intuit disclaims any responsibility for the accuracy or adequacy of any positions taken by you in your business finance. If you have questions regarding accounting issues specifically related to your industry or your business circumstances, you should consult with your own professional tax advisor, accountant, attorney, industry expert or professional association.