Move Carefully When Using Financing From Friends and Family

More than half of all small businesses in the U.S. are self-financed by the entrepreneurs themselves. The second most utilizing funding source isn’t banks or venture capitalists; it’s friends and family.

And it’s understandable. Rather than having to introduce and prove yourself to strangers, you can make your case to people acquainted with your character, experience, and work ethic, usually in a familiar, more comfortable setting than a loan office. The interest and payback terms for loans from friends and family also tend to be far more generous and flexible than anything offered by a lending institution.

Of course, this seemingly ready source of small business financing has a downside. Too often, the loans are vaguely structured, with unclear expectations about when and how the loan will be paid back. Relationships could be stressed beyond repair if things don’t work out as planned, and you’re forced to limit repayment or even default. Some friends or relatives may also expect certain perks in exchange for their investment, from free access to products or services to a job or a say in how the business is run.

Rather than assuming everyone understands the conditions of the loan, it’s best to lay out the terms and conditions, and put everything in writing. Sometimes, a “Promissory Note” is all it takes to document a loan from a friend or family member. While there are several online templates and forms for constructing your own Promissory Notes, it’s often helpful to have an attorney examine the document before anyone signs it.

You can also find help from online services such as Zimple Money (www.zimplemoney.com) or Prosper (www.prosper.com), which offer assistance with structuring and administering loans. For example Zimple Money provides automatic billing and collection, including payment alerts and reminders, accounts posting, and tracking. Payments can be made via direct deposit, helping speed repayment to your backers.

Even if the participation of friends and family members is limited to a simple loan, be sure to keep them abreast of your small business’s progress. Success may inspire them to step up once again when you need cash for an expansion. But don’t be afraid to share less encouraging news either. Being up front and frank will make it easier to renegotiate the loan terms if necessary. And always be prepared to deal with hard feelings from someone, even if you’ve done all you can to ensure they are treated fairly.

To learn more about financing options for your small business, contact Raleigh SCORE, “Mentors to America’s Small Business.” SCORE is a nonprofit organization of more than 60 volunteers in the Triangle area who provide free, confidential business mentoring and training workshops to small business owners. To see how SCORE can help, or to request a face to face meeting, go to http://raleigh.score.org.

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