Should Business Owners Borrow Money from Family?
Use these 5 Success Tips when Getting a Loan from Relatives
Mar 18, 2009
There's no doubt that borrowing money from family can be risky. After all, a bad loan arrangement has the potential to damage the business and personal relationship with the lender as well as other family members. There’s nothing more embarrassing than having someone ask for a loan repayment while folks are trying to catch up at a family reunion.
On the other hand, getting a loan from relatives can be a godsend. Unlike a banking institution, a family member isn't just looking at the borrower on paper. The borrower's integrity, reliability, and character can far outweigh a bad credit score. Plus, family members may have a personal stake in seeing the business succeed. That kind of support is invaluable.
Borrowing Money from Relatives is Old News
Family financial support is responsible for many of today’s American businesses. Just ask Wal-Mart's founder Sam Walton. His father-in-law loaned him $20,000 to start the discount retailer. There’s also John Mackey. The founder of the Texas-based chain Whole Foods opened his first store with funds that he borrowed from family and friends. In addition, Subway was started as a result of Fred DeLuca borrowing $1,000 from a family friend. Now the fast food chain boasts 22,000 restaurants worldwide.
“After self-financing, the second most popular source for startup money is composed of friends, relatives, and business associates,” writes Rieva Lesonsky in her book, Start Your Own Business. According to the author, there are ways to make the arrangement advantageous for the borrower and the lender. "If you handle the situation correctly and tactfully," she adds. "You may gain more than finances for your business--you may end up strengthening the personal relationship as well."
Borrowing Money from Family Has Rules
So how do business owners hit up their relatives for cash without hurting the relationship? Here are 5 tips for success:
- Be Honest. The business owner should tell potential lenders about the business’ goals, competitors, potential risks, and challenges. The positives and negatives of the business should be presented so the potential lender can make an informed decision.
- Be prepared for rejection. The potential lender should never feel obligated to make the loan. The small business owner should be more concerned with preserving the family relationship than obtaining the money and that should be communicated.
- Be open-minded. Providing money isn't the only way that a relative can lend support. Maybe the lender would rather co-sign a loan than hand over cash. Or, perhaps the relative would be interested in becoming a limited partner or exploring some other business opportunity.
- Be meticulous. Everything should be documented. The written agreement should state how much money is involved, the payback terms, the interest rate, and the consequences if the loan isn't repaid. It should also outline whether the loan is secured or unsecured and the interest rate.
- Be diligent. Payback should start ASAP—even if the initial payments are small. This gesture builds trust and demonstrates the business owner's sincerity and professionalism. There should be a paper trail of all payments which should consist of cancelled checks or receipts.
Borrowing Money from Relatives Resources
Organizations, like Virgin Money (www.virginmoneyus.com) and the Small Business Administration (www.sba.gov), can help borrowers more formally manage these very sticky situations.
A business owner that handles these loans wisely may find that their family is their most powerful ally in business and life.
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