Friends and family loans can work
Without the good old family loan we wouldn’t have companies such as Walmart, Motown Records, GoPro, or Amazon. And without a loan from Mrs Dyson, her husband would never have had the funds to develop his first cyclonic vacuum cleaner in the late 1970s.
Pros and cons of family and friends loans
How to borrow responsibly from family and friends
There’s nothing wrong with starting a business with a family loan or one from a friend. No one knows you better. Plus they’ll often give you better, more flexible lending terms. For instance, they may not require any security, they won’t charge you an application fee, their interest rates might be lower (or zero!), and they might let you skip a couple of payments.
But there are some guidelines you should follow to prevent turning those friends into courtroom litigants, or being cut out of the will.
Pitch as you would to a bank or investor
Keep it professional but friendly. Show them why it’s a good idea to lend you money for your business.
- Don’t expect them to stump up every cent – explain what you’re putting in and what you’ll be taking out
- Be clear with them about how much you need and why
- Take them through your budget so they can see you intend to spend their money wisely
- Be open and transparent, and manage their expectations – explain the risks and show them best and worst case scenarios
- Make sure they understand they can’t get their money back quickly if a family emergency comes up
- Show them how and when you plan to repay them
Loan, investment, or gift?
This can be one of the biggest misunderstandings when taking money from family or friends. Make sure all parties know what the situation is – especially other family members who might think you’re about to blow their inheritance on a pipe dream.
- Investment vs loan: A loan might be better if you don’t want your friend or family member telling you what to do. Learn more about the difference between an investment in your business and a loan in the chapter on debt vs equity finance.
- Loan vs gift: If you’re not paying interest or making repayments, the tax office could hit the person lending you the money with tax or penalties. Be aware of the rules.
Put it in writing
Create a formal record of the agreement. It will help you avoid misunderstandings at the outset, and it can be used to resolve disputes.
If it’s a loan, document the following:
- the amount borrowed
- the interest rate (if applicable)
- the length of the loan including start date and final repayment date
- repayment terms – regular amounts or a lump sum when the business reaches a certain stage; whether early repayment is okay
- security (if applicable)
- penalties for late or non-payment – for example, increasing the interest rate, changing the loan terms, adding extra costs to the loan, taking of security, or instigating court action
For extra peace of mind, get a lawyer or accountant to take a look. To help get you started, check out our loan agreement template below.
If it’s an investment, the agreement will be far more complex. The document will need to say how many shares the investor gets and whether or not they have a say in business decisions. It should also explain if they’re going to be held responsible for business debts or lawsuits. Definitely get a lawyer and accountant involved in writing one of these.
Always follow through
Do what you said you’ll do. And give the lender a heads-up if things aren’t going the way you hoped. You don’t want them hearing from third cousin Bob.
- Make your repayments on time. If they can see the money coming back to them they won’t begrudge it when they see you spending some money on yourself.
- Give them a report at year end – how the business is doing, how much you’ve repaid, any obstacles you might be facing.
- Be professional and treat them with respect. A successful relationship with a friend-or-family lender can be good evidence to put in front of a professional lender further down the track.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
How to finance your business
Need finance for your business? Learn about the types of finance, approaching lenders and investors and more.
- What is business finance?
Your new business idea is ready to go. Now you need to find the right small business funding. But where do you start?
- How much business funding do you need?
Knowing how much money you need will help you choose the right type of finance. These tips will help you find a number.
- Debt versus equity finance
Most forms of funding fall into one of two camps. Let’s look at the main pros and cons of debt versus equity.
- Main types of finance
It takes money to make money. So what sort of finance options are there? Here are the types that fund most businesses.
- How to get a business loan
Getting a business loan is still one of the most common ways to finance a business. So let’s look at how to get one.
- Peer-to-peer lending
Peer-to-peer lending is an alternative method of getting a business loan. How does it work?
- Friends and family loans
Friends and family loans may be available when other types of finance aren’t, but they do require some precautions.
- Invoice financing
Ever thought your cash flow would be better if everyone just paid what they owed you? Well, you may not have to wait.
- How to find investors
How do you find investors for equity financing? Let’s look at what types there are and where to locate them.
- Angel investors versus venture capitalists
Angel investors and venture capitalists are alternative finance sources. What can they offer your business?
- How crowdfunding works
Crowdfunding can get you the money to build a business, and the attention to build a customer base.
- Small business grants
Grants are a great funding option for some businesses. They can be a lot of work to get, but the reward is free money.
- Pitching for business funding
Seeking business funding is a major step but you needn’t be daunted. Here’s how to pitch your business.
- Tools and guides for your business
Now that you’re in business, you want to stay there. Xero’s got resources and solutions to help.
Download the guide to financing your business
Your intro to the different types of finance, including their pros and cons. Fill out the form to receive our finance guide as a PDF.