It seems that everywhere we look these days, there are examples of “alternative financing.” Peer-to-peer financing, crowdfunding, you can even pick up financing with your groceries at the local supermarket. But one of the most common ways to get money that isn’t from banks has been around for hundreds of years.
Of course, I’m referring to the loan from friends and family.
It is logical that so many of us will take out loans from friends and family to help with our businesses. According to LendingTree, the number could be as high as 53%.
Asking for a loan from friends and family should be easy and natural, because close friends and family members know you to be trustworthy and capable, right? But remember, borrowing the car isn’t the same as asking for financial assistance.
Even though borrowing money from family and friends might seem like an easy way to avoid dealing with banks, it could be a much more complicated situation, so you’ll need to plan in the same way you would when dealing with a professional investor. Here are some fundamental guidelines:
Act as if the loan from friends and family came from strangers.
It can help to forget that the person you are borrowing from is a friend or family member.
Make it an «arm’s-length transaction» and ask for the same legal paperwork to be prepared as if your investor were a complete stranger. Why? Because if the terms of the loan have only been discussed verbally but not in writing, it can have several negative consequences.
For example, the lender may step in if they think you’re not running your business correctly. This can lead to animosity and social friction. Before accepting any loans from friends or family, be careful to consider both parties and document as much as you can. Depending on the nature of the loan and business, it is also sometimes wise to consult with a solicitor.
A solicitor can draft an I.O.U. (also known as a «promissory note») for the friend or relative, and agree on an interest rate that will be considered a «commercial» rate in the eyes of the law.
In most cases, debt may be preferable to equity. You only need to return money that has been «loaned» to you with interest. Therefore, a lender cannot direct how your business should be run. A person becomes your business partner legally if they purchase stock in your company. When in doubt, make the transaction a loan and make prompt repayments. If a friend or member of your family is adamant about purchasing stock in your business, attempt to make it non-voting shares so they won’t be able to criticize all of your management choices.