This post originally appeared on Entrepreneur.com - #StartingABusiness
Getting a loan from loved ones can pay off — with some parameters.
5 min read
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The first time I borrowed money from family to start a business, I made a complete fool of myself. I asked my dad for $2,000 to secure a position in a multi-level marketing (MLM) scheme that was sure to earn me millions. I was young and naive, but he trusted me and agreed to help me out. Sorry, Dad. How was I to know that hawking magnets with magical healing properties wouldn’t make me rich?
A few years later, I founded a legitimate business repairing commercial signs. I had some success, but my complete lack of credit history meant I couldn’t secure the financing needed to take it to the next level. Once again I went to my dad, and once again he came through. This time, his faith in me paid off. My business grew rapidly thanks to his largesse, and life was never the same.
If you’re considering borrowing money from friends or family, here are some recommendations.
1. Be clear about the risks.
The first time I borrowed money from my dad, I was so cocky about my ability to repay him that the fact that he was taking a significant chance never even came up. That was a mistake. I was lucky in that he forgave me and that there was no lingering resentment or mistrust, but I felt terribly ashamed about my failure and wished I’d been more pragmatic with him when pitching the MLM.
Be absolutely certain that your friends and relatives are aware of the risks inherent in lending you money for your business. Be painfully honest that you might not pay them back. Make sure that everyone is okay with the potential consequences, and keep the transparency going once the money changes hands. Provide updates about your progress and continue to earn their confidence.
2. Seal the deal in writing.
Memory is a funny thing. Let’s say a friend assures you that he’s 100 percent cognizant of the risks involved in lending you money. He’s ready to accept a worst-case scenario. You shake hands over the deal while looking each other square in the eye. Fast forward a year. Your business has gone under and you’re broke. Your friend is probably going to remember just one thing: He lent you money and you promised you’d do your damndest to pay it back.
In these situations, it helps to have done some paperwork. A formal agreement ensures that everybody’s on the same page about the loan. You’ve dotted your i’s and crossed your t’s down to the last detail. A formal agreement is also a tool for helping you stay organized regarding both spending and repaying the loan. It should spell out the size of the loan and a schedule for repayment.
If you really want to be thorough, hire a lawyer to inspect your contract. Have everyone sign on the dotted line and take a copy for their records. It’s not uncommon for family or friends who provide business loans to assume that they now have a say in how you run your business. A formal agreement can nip that sort of headache in the bud.
3. Be proactive about repayments.
Oftentimes when you borrow money from family or friends, you set up a payment plan. Never put them in the position of having to remind or harass you to keep up your end of the bargain. I remember a friend who had a small business that was doing pretty well. He got a little tangled up in some financial complexities, and I lent him a pretty significant amount of money to help him extricate himself from the situation and keep growing his business.
We wrote up an agreement about repayment terms. I told him that I didn’t ever want to chase him down for a repayment. If he had a slow month and couldn’t come up with the funds, I didn’t want to have to look for him. Our personal and business relationships were stronger for it.
Communicate proactively if you get in trouble. Remember who your lenders are and what they mean to you. Be open and honest about your situation; they’re much likelier to be reasonable and understanding if you face them directly rather than hide from them and stop returning calls.
Borrowing from friends and family to grow your business is a sensitive, complicated, uniquely emotional transaction. As I know from personal experience, it can also be a hugely rewarding experience for both sides.