Loan from family and friends

Why borrow from family and friends?

Raising finance from family and friends can be rewarding for both parties.

  • you get the finance to start or expand your business: and
  • your family and friends have the satisfaction of helping you while earning interest on their spare cash.

Family and friends may accept more flexible terms and conditions that are better suited to your business than those offered by commercial banks.

Often arrangements with family and friends are informal and based purely on trust and verbal assurances. However, a formal written agreement is strongly advised in order to minimise disputes in the future. Preserving your relationships with friends and family is as important as pursuing your business opportunity.

Be aware of the tax implications of interest on loans from family or friends. The lender has to declare the interest received as taxable income, and you can deduct the interest as a legitimate business expense. If the loan has no interest then there are no tax implications for either party.

Follow these key steps when borrowing from family and friends:

Sell them your vision

Practice a one-line pitch that clearly communicates the vision for your business. Tell them why the business idea will work, and what you will do to make it work. Tell them your back-up plan to pay them back if the business doesn't work.

Ensure it is a loan, not an investment

Make it clear that the money you are asking for is a loan and that you will pay it back. It is not an equity investment. Family and friends are entitled to get back what they loaned you, with interest, and a performance bonus if you achieve a specified level of financial success. However, a loan does not mean they have bought equity in your business.

Prepare a repayment plan

Prepare a realistic repayment plan that is based on the financial forecasts developed for your business plan. Document the plan and include a reasonable and easy-to-understand interest rate.

Draft a formal loan agreement

Once you have agreed on a repayment plan, you should draft a formal loan agreement to protect both parties. A formal agreement, or contract, ensures that everyone understands this is a business arrangement.

Your agreement should include, but not necessarily be limited to, the following issues:

  • term of the loan, payment amount, and repayment schedule;
  • interest rate, and whether it is calculated and compounded every day, week, month, quarter or year;
  • the process for managing late or missed payments, including penalties;
  • how and when the loan will be paid if the business fails; and
  • any special payment arrangements, such as no payments for the first year, interest-only payments, seasonal payments, or bonus payments.

It is strongly that recommended you seek professional advice before entering into any contract.

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Related Information

Business Briefs to view:
Recovery of a Debt
Applying for Finance

Business Guide to view:
Records Management Tips

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