Borrowing from Friends and Family

Borrowing from Friends and Family

Your own resources may not be enough to give you the capital you need to start your own business. After self-financing, the second most popular source for startup money is composed of friends, relatives and business associates.In fact, “most businesses are started with money from four or five different sources,” says Mike McKeever, author of How to Write a Business Plan.”Family and friends are great sources of financing,” says Tonia Papke, president and founder of MDI Consulting. “These people know you have integrity and will grant you a loan based on the strength of your character.”

It makes sense. People with whom you have close relationships know you are reliable and competent, so there should be no problem in asking for a loan, right? Keep in mind, however, that asking for financial help isn’t the same as borrowing the car. While squeezing money out of family and friends may seem an easy alternative to dealing with bankers, it can actually be a much more delicate situation. Papke warns that your family members or friends may think lending you money gives them license to meddle. “And if the business fails,” she says, “the issue of paying the money back can be a problem, putting the whole relationship in jeopardy.”

The bottom line, says McKeever, is that “whenever you put money into a relationship that involves either friendship or love, it gets very complicated.” Fortunately, there are ways to work out the details and make the business relationship advantageous for all parties involved. If you handle the situation correctly and tactfully, you may gain more than finances for your business–you may end up strengthening the personal relationship as well.

The Right Source:-The first step in getting financing from friends or family is finding the right person to borrow money from. As you search for potential lenders or investors, don’t enlist people with ulterior motives. “It’s not a good idea to take money from a person if it’s given with emotional strings,” says McKeever. “For example, avoid borrowing from relatives or friends who have the attitude of ‘I’ll give you the money, but I want you to pay extra attention to me.’ “

Once you determine whom you’d like to borrow money from, approach the person initially in an informal situation. Simply let the person know a little about your business and gauge his or her interest. If the person seems interested and says he or she would like more information about the business, make an appointment to meet with them in a professional atmosphere. “This makes it clear that the subject of discussion will be your business and their interest in it,” says McKeever. “You may secure their initial interest in a casual setting, but to go beyond that, you have to make an extra effort. You should do a formal sales presentation, and make sure the person has all the facts.” A large part of informing this person is compiling a business plan, which you should bring to our meeting. Explain the plan in detail and do the presentation just as you would in front of a banker or other investor. Your goal is to get the other person on your side and make him or her as excited as you are about the possibilities of your business.

During your meeting-and, in fact, whenever you discuss a loan-try to separate the personal from the business as much as possible. Difficult as this may sound, it’s critical to the health of your relationship. “It’s important to treat the lender formally, explaining your business plan in detail rather than casually passing it off with an ‘if you love me, you’ll give me the money’ attitude,” says McKeever.Be prepared to accept rejection gracefully. “Don’t pile on the emotional pressure-emphasize that you’d like this to be strictly a business decision for them,” says McKeever. “If relatives or friends feel they can turn you down without offending you, they’re more likely to invest. Give them an out.”With bank loans so hard to come by, a growing number of businesses are borrowing from family and friends as a way of getting low cost funding without having to jump through too many hoops.But while borrowing from friends and family can be a great way of getting inexpensive funding for your business, it can also be a recipe for disaster, leading to family arguments, breakdowns in relationships and even legal action. Here’s how to do it right:

1. Take it seriously. Borrowing money from a family or friend is a big deal for both you and them, so treat it that way. Give them a formal presentation so they know exactly what they are getting themselves into. Explain what the money will be used for and provide regular updates on the progress of the business.

2. Make it clear whether it is a loan or equity. Are you borrowing money that you plan to pay back? Or are they investing in your business in return for an equity stake? Make sure both sides understand exactly what is taking place and the consequences. If it is an equity investment, for example, then if the business fails they will lose all their money – and even if it is a success they may not be able to realise their investment for many years.

3. Do not borrow more than your family or friends can afford to lose. This is really important, and requires considerable careful personal judgement, especially if the lender is an elderly parent who may well be quietly making financial sacrifices elsewhere in order to help the next generation get a venture off the ground. If your business fails you need for it to be a shame not a crisis; and not so awful that it compromises your parents’ retirement plans.

4. Be honest about the risks involved so that your family and friends go into the venture with their eyes open. If they think you are creating the next Facebook and you have done nothing to correct that impression, then both you and they could be in for a nasty shock.

5. Determine upfront the extent of their involvement in the day to day running of the business or in deciding the strategic direction of the business, if any. If you haven’t laid out clear ground rules in advance then a relative or friend who has lent money may believe he then has a right to get involved in decisions about the direction of the business. If they are popping into your office everyday with ‘helpful’ suggestions, then things could get awkward fast.

6. Put everything in writing so both sides know what is involved. It may sound overly formal but it is really important. If it is a loan, will you pay them interest, and over what time period you will be paying them back – in regular monthly sums, or in lump sums depending on how the business is doing? And what happens if the business fails? No matter how well you know someone, a casual conversation can easily be misinterpreted and mean different things to different people even at the time, never mind years later. If you write it down there is less likely to be room for any dispute.

Alan Pluck is the chief executive of Portobello Business Centre, an enterprise agency which helps start-ups and small businesses. He says: “Draw up a schedule of when the payments are going to be made, and how, and agree what happens if you can’t meet the payments, for example if there can be a break. Putting it all in writing will not necessarily stand up in a court of law, but the process of writing it down strengthens the chances of it going smoothly. If it is in writing then no-one can argue with it.”

7. Avoid talking about it at family occasions. Try to keep business talk separate from family life and social events with friends because otherwise everyone else will get really bored – and then they will get cross with you for spoiling the occasion.

8. Put family first. If a friend or family member has lent you money and your business shows signs of becoming really successful, then instead of paying back all the loan, consider offering them a slice of equity in return for the amount outstanding. It may cost you more, but if it keeps the peace, it’s a small price to pay. And if you are not prepared to put your friends and family first, think carefully about whether this really is the best financing route for you.Budding entrepreneurs often turn to a lender that overlooks weak points, provides flexible terms, and offers a dream-come-true interest rate: the Bank of Mom or Dad. Without an established track record, start-ups often have trouble getting a traditional bank loan or funding from venture or angel investors. So after tapping their savings, founders often turn to informal investors, which usually means family members and friends.Such arrangements combine best wishes, a pay-me-when-you-can attitude, and few expectations of a meaningful return. That might be the most realistic view of family and friends financing. So in many cases, it might be wise to not formalize the loan since doing so can raise expectations that it will be repaid in full.

Many people will opt for a loosely structured deal in which, for example, repayment may start only when a company has reasonable cash flow and can afford to make payments — a position many businesses don’t reach until three to five years down the road, if at all. Such an arrangement doesn’t raise expectations of prompt repayment. But such vagueness can lead to problems and confusion later on, prompting some experts to urge putting into writing whether funds are a loan, a gift or an investment. Still, terms of the agreement need close attention. Failure to collect interest or a repayment might prompt the Internal Revenue Service to decide the “loan” was actually a gift and impose gift tax and other penalties.
Online services, such as Prosper Inc. and Virgin Money, a unit of Virgin Group PLC, offer to structure arrangements between borrowers and individual lenders, who are often relatives or friends. For smaller loans, Virgin Money, for example, provides documentation and a payment schedule. For larger business loans, it will service the loans, send payment reminders and provide year-end reports. A more formal plan for larger loans services the loan — including setting up electronic fund transfers, sending email reminders and providing online account access. It also sends out year-end reports to the borrower and lender. The loans are flexible, usually offering lengthy grace periods and interest rates and payment schedules favorable to the business owner.

Some planners note that family members can provide money as an annual gift, helping reduce the size of an estate subject to taxes. Gifts also ease worries of conventional lenders who might be concerned that family loans could impair their ability to collect. One other thought: Some family members who provide loans or gifts think the funds come attached with the right to have a say or participate in the business. Documentation can spell out such issues.

Content Credit :- Caroline Layzell Yoga Teacher Bali

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