Friends and family loans

Friends and family loans

The bank of mum and dad has helped launch many a business. It’s often available when other types of finance aren’t. You just need to take a few extra precautions.

They can work well

Without the good old family loan we wouldn’t have companies such as Walmart, Motown Records, GoPro, Poundland, 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.

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 penny – 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 loans 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.

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.