Starting a business takes time, hard work, and money. While time and hard work are usually in abundant supply for budding entrepreneurs, money is a common shortfall. Many experts advise aspiring business owners to turn to family members for seed money to start a new venture. Certainly, borrowing money from a family member can be mutually beneficial when handled appropriately. However, if handled wrong it can be disastrous to both the business and the family.
Asking for money from family members should be treated with the same care and attention you would give if seeking a loan from an investor or lending institution. The first step is to be prepared to request the money. This means creating a solid business plan, which will demonstrate why your business idea is a worthwhile investment. When you develop a business plan you are documenting how and why your business will succeed. The information in a business plan enables the family member lender to make an informed decision about taking the risk of helping to fund your idea.
One of the biggest mistakes when borrowing or loaning money within a family is neglecting to formalize the agreement with a legal document. Even when dealing with family (or perhaps especially when dealing with family), a contract or promissory note protects all parties. A formal contract will firmly establish the conditions of the loan, including the repayment schedule, penalties for late or nonpayment of the agreed upon installment, or provisions for early payment of the outstanding balance. Other terms may be added. For example, the contract may stipulate that the lending family member receive information about company profits and losses on a periodic basis.
Your family member may choose to become an investor so that they can make more money in the long run. Here again, it is important to formalize the arrangement with a legal document. Being an investor offers some protection and benefit to the family member but also gives them a say in how you operate your company. The technicalities of the investment would need to be agreed upon in advance by the two of you. For example, you may determine that if the company succeeds, you will provide a pre-determined percentage of the profits, monthly, quarterly or annually.
Whether arranging a loan or setting up an investment, a small business attorney can help you to prepare the documents. If you want to set up a simple agreement, you can find a variety of templates for loan documents and contracts by searching on the internet.
One of the greatest challenges of bringing a family member into your business in a financial capacity is protecting the personal relationship. If things do not go well, and your family member sustains a loss, you still have to see them—at least during family holidays. For this reason, it is essential that the two of you discuss any potential difficulties or risks in the business so the personal relationship itself is not put at risk. It is important to be as open and up front with you family lender as you are with yourself, perhaps even more so, so that they understand how things stand and what they are signing up for. And keep communicating. If lines remain open and information is honest, you can work through even the most difficult times that might come up.
On the flip side, one of the greatest joys of bringing a family member into your business is the satisfaction that comes with great success—a success that your family has materially contributed to. If you have planned realistically and know that your idea is a winner, there is every reason for you and your lending family member to expect this reward as your business grows.
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