Starting, running a business is not for the chicken-hearted!! After all, it takes a strong heart and mind to wade through difficult situations, take difficult decisions. A case in point being the decision to borrow funds –as, in case of small start-ups, bank/institutional credit may be difficult in the absence of proven track record. In many such cases, people turn to their family or friends for their funding requirements. But before you decide to borrow from family or friends, but be sure to look at the pros and cons.
Advantages of Borrowing from Family/Friends:
• Lower Interest Rates: One of the biggest advantages of borrowing money from family is that you are likely to pay a lower interest rate than you could get at a bank or credit union.
• Absence of red tape: Bank/institutional loans’ documentation requirements can leave you baffled and frustrated. Since you are just starting off, you might want to stay away from such time, effort consuming processes. Loans from family/friends are often a savior in this regard, as they are less likely to scrutinize your business plan with a fine-toothed comb.
• More Flexible Repayment Terms: Often, with family/friends, you get favorable repayment terms for your new business loans. For instance, you might be able to write a loan in which the repayment does not begin for six months to a year down the road. This gives you time to get your new venture off the ground without worrying about servicing the debt right away.
• Established Relationship: Family/friends, whose trust you enjoy, are more likely to have faith in your business idea. However, it is always a good practise to show them a structured business plan so that your close family/friends do not feel that they are being taken for a ride.
Dis-advantages of Borrowing from Family/Friends:
• Unsolicited advice: By lending you money, your relation/friend may feel that he or she is now part owner of the company, with a right to call the shots and make business decisions. Deal with any such form of meddling by making it clear that this is strictly a financial decision, and that you will be the one in charge of the day-to-day operations of the business.
• Lack of Clarity: Treating loans from family/friends as informal transactions is a business hazard and can lead to complications and souring of relationships. Avoid this by documenting the loan including interest rate, repayment terms etc. The person lending you money should also read the document carefully and have his lawyer vouch it, before agreeing to the terms.
• Complicating Relationships: This being the biggest drawback of taking money from your family/friend, most people shy away from taking loans from family/friends. Consider and identify the risk before taking out the loan — make contingency plans for paying back the money early if need be.
Formalizing a Loan Agreement: It is always a good idea to formalize your loan even if you have borrowed the money from your grandma or best friend!!! Consider the following
• Decide whether the investment be equity or a loan. If the money is treated as equity, your friend or family member will own part of your business. If it is a loan, you will repay it within a set period of time, including interest.
• Mutually agree on: A reasonable interest rate on the loan. An acceptable time-frame for the loan repayment. Possible penalties for not paying on time or defaulting. Both your business and your relationships are important. Do make sure that money matters do no spoil it. Venture with care.