Borrowing money from friends and family is one of the most common ways small businesses get their start, according to the Small Business Administration. And while the intersection of money and loved ones can create some bumps in the road, there’s also the potential for tremendous benefits.
Read on to learn about the various ways you can ask friends and family for business funding, as well as the benefits and disadvantages you might experience along the way.
What Are Startup Business Loans From Friends and Family?
Startup business loans from a friend or family member occurs when someone you know funds your business and expects to be paid back at some point.
Friends and family can often be more flexible with their terms than a traditional lender. Under the terms of your agreement, you may have to pay back principal and interest or be required to pay back the lump sum at an agreed-upon future date with interest.
One advantage of borrowing from friends and family is that you won’t have to worry about a credit check to qualify. Plus, if you need extra time to pay, you won’t risk your credit standing.
Other Ways Friends and Family Might Fund Your Startup Business
In some instances, your friends or family members might not expect to be paid back for the funding they provide. Here are a couple of examples.
In some cases, a friend or relative wants to become your patron without expecting a return on the investment. In other words: Funding for your endeavor is motivated out of sheer support or belief in your cause or idea, which can lead to a cash gift.
You and your patron have to be careful, though, because gifts can get expensive if they exceed IRS gift tax thresholds. According to the IRS, for the years 2018, 2019 and 2020, a person can gift another person $15,000 per calendar year without paying a gift tax. If you’re calling the funding a gift, your patron may want to keep it under that amount.
If your new business idea resonates enough with friends and family, they may want to become part of the process, which could result in them investing in your business as a partner of some kind.
Investors become part owners or have a continuing stake in the company. They may not require the funds be paid back with interest — opting to accept a share of profits in the future. Depending on how well your business does, this type of funding can work in the investor’s favor.
Tips for Borrowing From Family and Friends to Start a Business
Turning to friends and family for startup business funding is a viable option. But take the process seriously. Your relationship with the person who loans you the money can be utterly transformed by how you handle everything — from setting up the transaction to the final repayment.
Here are some tips for approaching friends and family members to borrow money for your business.
- Treat it like any other financial transaction: If you and your friend or family member decide to structure the contribution as a loan, you should plan on making regular and timely payments — even if they’re lax or understanding about lateness. By making regular payments from the beginning, you are conveying your appreciation for their help and that you don’t take it for granted.
- Have everything in writing: Even though they’re a friend or family member, putting agreed-upon terms on paper is wise. A written agreement, even though it’s not as binding as one from a bank or lender, should be approached professionally. Be sure to include how much you’re borrowing, payment terms and any interest involved.
- Ask for the amount you need and not more than that: Writing out the loan terms on paper can help with this step. You should have the amount of funding you need worked out based on your own research and calculations. Avoid getting pulled into borrowing any more than that. Be clear and concise about exactly how much money you need, what you need the money for and what value it will add to your business.
What Are the Benefits of Startup Loans From Friends and Family?
Approaching friends or family members for startup funding might be daunting, but it could be well worth it. Take a look at these potential benefits.
- Belief in you and your cause: Your friends and family know and, hopefully, believe in you. Your relationship can make it easier for you to get money for your business idea — even if that idea doesn’t check all the traditional marketable boxes that banks require.
- More favorable terms: Since individuals have a lot more flexibility in how they handle investments and loans than other lenders, you may also be able to work out more favorable terms with a friend or family member.
For example, perhaps you’ll receive money you don’t have to pay back for five years. Or you might be given a loan with the understanding that you’ll both sit down to talk about payments in a year, and terms will depend on how the business is doing at that time. Another option is that a friend might help fund your business in exchange for free services once you get started.
- Free marketing and support: A third big advantage is that when family or friends invest in your business — even if they don’t become a partner — they tend to remain attached to your success. That translates to free word-of-mouth marketing, online sharing and other support, which you certainly don’t get from many traditional lending sources.
What Are the Disadvantages When Loved Ones Help Fund Your New Business?
As with any major decision, there are potential disadvantages to asking a friend or family member to fund your business. Here are a couple to consider.
- You’ll risk your relationship: The biggest disadvantage is one that is inherent to the process: You’re dealing with friends and family. That can put some weird pressure on your relationship, and it could mean that the person thinks they have a right to interfere in or advise you on your business.
Consider establishing some written ground rules about the financial relationship if you allow friends or family to fund your business idea. Hence the reason why putting everything in writing is a smart move.
- It won’t improve your credit: Another potential downside to this type of loan is that it won’t do anything for your personal or business credit, which means you can’t leverage it in the future when seeking other types of business capital or investment options. On the flip side, however, if loans from friends and family do help you succeed in launching your company, it can put you in a position to eventually build business credit.
The Bottom Line
Anyone can qualify for a loan from friends or family, which makes this one of the easiest first steps for starting a business. You’re only limited by what your loved ones are able and willing to do for you. Plus, when borrowing from friends and family, you don’t have to worry about negative impact to your credit.
If you do go to friends and family for business funding, treat it as objectively and professionally as you would when borrowing money from a financial institution. By being disciplined with loans from family or friends, you can maintain good relations with them on a personal and financial level.
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