Almost every new business requires some sort of outside funding to get off the ground. New business owners in particular may struggle to get loans without a sufficient credit history. Many entrepreneurs are forced to turn to their family and friends for help.
Before approaching family and friends for funding, do your research and take steps to be ready to make a funding request.
Some of the advantages of turning to friends or family members for your next business loan are outlined below.
One of the benefits of borrowing from loved ones is that you usually don’t have to go through the same financial hurdles as you would if you tried to secure a bank loan.
Additionally, private lending from friends and family can allow for more flexible repayment schedules. For example, you can include in your written agreement details like a grace period that allows you to halt payments while your business is getting off the ground, or set out conditions where your repayment can be delayed.
Lower Interest Rates
Borrowing from friends and family is often at a lower interest rate than you can get from a bank. A lower interest rate translates into a reduced overall debt level, which can boost long-term credit for your business.
Along with the satisfaction of helping a friend or family member, investors may enjoy being part of the business-formation process while earning returns.
Loan arrangements between family and friends can be complex. Some of the social and financial considerations of accepting a loan from a friend or relative are outlined below.
Lack of Clarity
There can be a lack of clarity that can be detrimental if borrowers and lenders have different expectations and written agreements are not specific.
For example, friends or family members who lend you money may assume their financial investment gives them a stake in the company or a voice in daily operations. On the other hand, borrowers may believe that it’s okay to miss the occasional payment since the lender is a friend. Carefully documenting all terms and conditions in advance can help the parties involved avoid misunderstandings.
It is good practice for borrowers to arrange for a business attorney to draw up a promissory note or similar document that outlines interest rates and payment terms, including penalties and late fees. Additionally, any documentation should stipulate what will happen if your business proves unsuccessful. Making an effort to make sure that the person lending you the money knows all the possible risks and rewards of investing in advance can help you to avoid disagreements down the line.
Insufficient loan documentation can expose your investors to IRS scrutiny. Loans and gifts have different tax implications, which is another reason why it is important to have any loans carefully documented.
Taking a loan from loved ones may open up unwanted dialogue about your spending habits. Setting clear payment terms and sticking to them can help borrowers and lenders understand boundaries. Taking time to make a solid plan and documenting your agreement formally can help all parties feel empowered and treated fairly.