Funding Your Business by Hitting Up Friends and Family

by Ed Martin on October 9, 2009

Borrowing from friends and family is second most popular form of business funding after self-funding.

They know you, for better or worse, and will lend you money based on trust for you. They are easy to approach because you know them. They are also often likely to be okay with not being repaid right away or at all. That makes borrowing a snap! But as usual there are some other things to consider.

Don’t take advantage of this generosity. Don’t hit up people who can’t afford to give you money. Don’t take advantage relationships. Don’t borrow from people where there is a risk of blow-ups or other drama that could jeopardize your relationship and your money. You don’t need that hanging over you. Consider what could happen to your relationship if your business fails and there is no payback of the loan.

You can receive money for your business informally from friends and family, with just a handshake and an understanding. That is easiest but there are some good reasons for being more formal. It is after all a business relationship. They are lending you money or investing in ownership in your business. Putting the terms in writing will help deal with pesky IRS questions about whether or not you got a gift or a loan. A loan is better from your point of view because you do not give up any ownership. A loan from a friend or family is not a license to get involved in your business. If you get an investment, you will give up partial ownership and control of your business. A loan lets you keep control in your hands.

A loan should be documented as such with a promissory note. It should have an interest rate and a provision to pre-pay. If your business fails, at least the person who lent the money can write it off. Documenting the loan will save everyone lots of IRS questions and problems. Of course, if you do document your loan, you have to follow through on the terms or risk IRS wrath.

There are times when a gift is better as long as it meets IRS restrictions. You don’t have to worry about repaying it. In the event that the person who gave you the money dies, there is no question about whether or not it is a loan or gift as long as the gift is documented. Also, a gift means that future lenders or investors don’t have to worry about being in line for repayment and so will be more likely to provide funding to you.

Websites That Help
Virgin Money is a website that helps structure loans between business owners and friends and families.
Prosper  helps match lenders and borrowers for microbusiness loans.

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Sources for Small Business Loans
April 1, 2010 at 9:13 pm

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1 Polprav October 21, 2009 at 10:16 pm

Hello from Russia!
Can I quote a post in your blog with the link to you?

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