The costs of starting a business can really add up. You need to consider the costs of a website, branding and marketing to attract customers. You might need to think about registering business names or setting up a company – and that’s before you even start buying stock, renting premises or perhaps get set up to work from home.
If you’re just starting out, borrowing from “the Bank of Mum and Dad” could seem like a great option. You might have parents, family members or even friends who are happy to invest in your business idea or be a guarantor for your lease or a bank loan.
This is not always such a good idea. In many cases, parents or other guarantors don’t realise the kind of financial commitment they are making by investing in a new business.
Here are some questions to ask before getting your loved ones involved in the financial side of your business.
How will the investment be treated?
If you do borrow from family or friends, it’s important that everybody involved understands exactly whether any money they invest is considered a loan to be paid back with interest, an interest-free loan or a gift that you don’t need to pay back.
Keep it professional by having a formal agreement in place. This agreement could cover how and when the investment will be repaid, including how often you’ll make repayments and a deadline to pay the amount back to your parents or family members.
Can your loved ones afford it?
Acting as guarantor for your business loan isn’t just a show of your family’s moral support: it’s a financial commitment.
They will be held responsible for any debt repayments you can’t make, which might include your lease or bank loan. In the worst cases, parents can lose their family home if their kids are not able to make repayments or incur a debt.
If you do need your parents to act as guarantor, try to limit their liability to an amount they could reasonably afford. For example, if you need them to guarantee your lease, you might negotiate with your landlord to limit their liability to a smaller amount such as $10,000. Just make sure this is written into the lease.
Have you conducted due diligence?
If you’re buying a business and asking others to invest in your decision, it’s important to complete a risk assessment and compliance check – a process known as due diligence.
Are you prepared for a “no” if they can’t help out?
Our advisers spoke with a mother who had been asked by her daughter to guarantee a lease for a chiropractic clinic. Her daughter had just graduated from university and didn’t have a client base. She was prepared to lease premises to run her own clinic for an annual rent of more than $50,000. The lease was for a period of five years with a yearly rent review. This equated to at least $250,000 over the entire rental period.
The parents were prepared to invest in their daughter’s future and initially thought they would be doing the right thing by supporting her. They hadn’t considered how their daughter was going to make the rental payments and associated leasing expenses from day one of her business.
Starting with no client base, she would need to make a minimum of $1,500 each week just to meet her expenses. Without any savings to draw from, it was apparent to the mother that her daughter was going to soon fall behind in her rent and she would be responsible for covering the entire lease costs, of over $250,000. The parent made the wise but difficult decision to say no.
Have you considered other options?
It’s worth exploring a number of different options to fund your business. You might be eligible for a small business grant if your business meets the criteria. You could look carefully into a small business loan but it’s important to understand exactly what you’re signing up for. Another option might be to start small, launching your business on the side while you’re working part-time or full-time in another role. That way, you have a dependable salary until your business is stable.
If your family are keen to play a part in your business, you can get them involved in ways that won’t cost them anything. For example, you could invite their feedback on your logo or website design, or ask if they’re willing to help with packaging your products or preparing for a marketing mail-out.
Please remember, the tips and details provided here in our blog are intended for general information only. If you would like advice about your specific situation, you might like to explore our free business advisory service. We also offer a free ‘Starting a Business’ workshop and a range of other services to help you through the purchase or launch of your business and beyond.