How to Structure a Family Loan for a Small Business

Friends and family loans tin piece of work

Without the good old family loan nosotros wouldn't take companies such as Walmart, Motown Records, GoPro, or Amazon. And without a loan from Mrs Dyson, her married man 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 unit and friends

There's nix wrong with starting a business with a family loan or one from a friend. No ane knows you better. Plus they'll often give you improve, more flexible lending terms. For instance, they may not crave any collateral, they won't charge you lot an application fee, their interest rates might exist lower (or zero!), and they might permit you skip a couple of payments.

But there are some guidelines y'all should follow to prevent turning those friends into court litigants, or being cut out of the will.

Pitch as y'all would to a bank or investor

Keep it professional just friendly. Bear witness them why it's a skillful thought to lend y'all coin for your business organisation.

• Don't expect them to stump upwards every cent – explain what you're putting in and what you'll be taking out
• Exist clear with them about how much y'all need and why
• Take them through your upkeep so they can run into you intend to spend their money wisely
• Be open up and transparent, and manage their expectations – explain the risks and show them best and worst case scenarios
• Make sure they empathise they can't get their money back quickly if a family emergency comes up
• Testify them how and when you lot plan to repay them

Loan, investment, or gift?

This can be one of the biggest misunderstandings when taking coin from family unit or friends. Make sure all parties know what the situation is – especially other family members who might retrieve you're about to blow their inheritance on a pipe dream.

• Investment vs loan: A loan might be better if y'all don't want your friend or family member telling you what to do. Acquire more about the departure between an investment in your business and a loan in the chapter on debt vs equity finance.
• Loan vs gift:If you lot're not paying interest or making repayments, the revenue enhancement role could hit the person lending you the money with tax or penalties. Be aware of the rules.

Put information technology in writing

Create a formal record of the understanding. Information technology will aid y'all avoid misunderstandings at the outset, and it can be used to resolve disputes.

If it's a loan, certificate the post-obit:

• the corporeality borrowed
• the interest rate (if applicable)
• the length of the loan including start engagement and terminal repayment date
• repayment terms – regular amounts or a lump sum when the business reaches a certain phase; whether early repayment is okay
• collateral (if applicable)
• penalties for belatedly or not-payment – for instance, increasing the involvement rate, irresolute the loan terms, calculation extra costs to the loan, taking of collateral, or instigating court action

For extra peace of mind, become a lawyer or auditor to take a look. To help get y'all started, bank check out our loan agreement template below.

If it's an investment, the agreement volition 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 organisation decisions. It should also explicate if they're going to exist held responsible for concern debts or lawsuits. Definitely get a lawyer and accountant involved in writing ane of these.

Always follow through

Practice what you said you'll do. And requite the lender a heads-up if things aren't going the way you hoped. You lot 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 lot spending some coin on yourself.
• Give them a written report at year terminate – how the business is doing, how much you lot've repaid, whatsoever obstacles y'all might be facing.
• Exist 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 farther down the rail.

Disclaimer: Xero does not provide bookkeeping, tax, business organization or legal advice. This guide has been provided for data purposes only. You should consult your ain professional advisors for communication direct relating to your business or before taking action in relation to any of the provided content.

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Source: https://www.xero.com/us/guides/financing-your-business/friends-and-family-loans/

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