Imagine you just started your own business and need money urgently to turn your dream into a reality. Imagine a lender that believes in your business offers you flexible terms and no interest at all.
Does that lender even exist?
Yes, it does. We are talking about your own family or your closest circle of friends.
In this article, you’ll learn the pros and cons of borrowing money from your family for your business, get the tips to do it right, and get informed about other alternatives that may be more suitable for you.
Borrowing Money from Family
While this type of lending alternative may work for a lot of business owners, especially at their early stages, you have to be aware of this: the informality involved in borrowing money from family or friends can turn into an ugly situation. The vagueness of the terms and a loosely structured loan can lead to confusion and drama.
What is worst, borrowing money from your beloved ones could put a wrench on their financial plans.
Pros and Cons of Borrowing Money from Your Family
Before you decide to borrow money from your family, weigh the advantages and disadvantages.
Low interest or no interest at all
Getting a loan from family or friends means there won’t be any interest. In most cases, your family or friends won’t ask a fee or percentage for the money they lend you. This is one of the best parts of this approach.
If you have a hard time keeping up with the payments, your loved ones are sure to be more understanding. You can work on flexible terms and deadlines with your family and friends.
No collateral required
If you fail to pay back the loan, chances are your family is not going to claim any of your possessions or your home; in other words, you won’t have to put up collateral when you borrow the money.
Borrowing money from mom and dad or a dear friend requires less paperwork than in a traditional bank or financial institution. This said, don’t fail to think your word should be enough. It’s highly recommendable to work on a loan agreement, as we’ll see in sections below.
Unlike most lending institutions that will require you to fill up forms, sign papers, and wait anxiously for days for approval or rejection, borrowing money from your folks will most likely get you a straight yes or no on the spot.
No credit history is required
Borrowing money from family doesn’t require credit history, nor will your credit standing be affected no matter what happens. As you may well know, most lending establishments give out loans only to those they’ve determined can pay them back at an interest rate. And that’s where your credit history/score comes in. It’ll tell them whether or not you’ll be worth giving a loan to. This credit background or rating doesn’t come into play when borrowing money from family or friends.
It’s a good option for startups
If you just started your small business, it’s going to be hard getting your loan approved in most financial institutions, which usually require at least two years in operations. Turning to your family and friends might be your best – and only option.
Borrowing money from family for business would generally spell a limited loan amount. The truth is, if you’re running a dynamic business that’s showing promising signs of bigger success and profits with possible expansion, you will need a considerable amount to cover costs of new or upgraded equipment, additional hires, or more extensive advertising and promotions. It’s not likely that your parents or friends can afford to lend you this kind of money.
It doesn’t allow you to build a credit history
If you’re planning to run and grow a business for the long haul, developing a strong credit history is crucial. You don’t get this when the loan comes from your folks.
You could give up part of the ownership
Any family member from whom you’ll be borrowing money could ask to be part-owner of your business. Whether or not you’d be comfortable with such an arrangement, you will have to be pragmatic and accept this possibility, especially if your family member also happens to have an entrepreneurial mind.
It may involve an uncomfortable situation
Asking your mom or dad for a business loan isn’t as easy as asking them to treat you for dinner at a steak house. Somehow, there’s some sense of embarrassment to it, some sort of lost pride when you take money from the folks.
They may feel entitled to give you their opinion
Your family or friends might think that since they’re putting up the money for your business or helping it expand, they should have a say on how you handle your finances.
It could stress your family’s finances
Borrowing money from family for business purposes could hurt their own finances. Probably your parents have been saving money for their retirement and old age. They’re taking a risk extending you a business loan.
It can have tax implications
You have to pay taxes on an amount of $14,000 or more given as a gift. Make sure you contact a tax expert or accountant to check if your family loan could have any tax implication.
It doesn’t provide you with tools and resources
Your family probably lacks a background in business and finances; therefore, they can’t offer you expertise in your industry or other resources in business management or finances.
Doing It Right
If, at the end of the day and after going through the pros and cons, you think borrowing money from family for your business might be your solution, then do it right.
Basically, you have to treat family members as formal investors. Even if the situation is more informal than what it would be in a lending institution, you should strive to follow these steps:
- Set up a formal meeting
- Provide information about your business (brochures, samples, or a formal pitch)
- Provide a business plan where you specify your plans of expansion
- State the exact amount you need
- Clearly and honestly explain any risks involved
- Offer equity, and be very precise in the kind of benefits or involvement you’re willing to offer
- Allow time to think, and properly thank them
- Formalize decisions in writing (as we’ll see in the next section)
The importance of elaborating a loan agreement
A loan agreement reflects the legal obligations of each party, in this case, the family member or members who are lending you money, and you as a business owner. Your loan agreement should include the loan amount, the interest rates, if any, the repayment schedule, the length of the loan, and any other relevant information.
Having a loan agreement in place can save you a lot of trouble in the long term, especially if you fail to pay off the loan or if any family member demands something that wasn’t agreed upon at the beginning.
You can find numerous online templates of family loan agreements that are simple and easy to follow and will work perfectly fine.
But, if you still feel like you need more guidance throughout the process, don’t hesitate to hire a lawyer, a financial professional, or an accountant. It may involve a fee, but it’s a well-worth expense: it provides you and your family with peace of mind.
Isn’t There a Better Alternative?
Of course, there is! There’s Camino Financial. These alternative lenders have been doing great business with business owners and entrepreneurs for years. Their small business loans combine the flexible terms that a family loan may have with the benefits and features a family loan can’t offer you:
- No collateral needed
- No credit history needed
- No pre-payment penalties: You can pay off your loan at any time
- Fast and easy process: Camino Financial requires less documentation than most lenders, and you could receive your funds within 4-10 days
- Good for startups: Your business only needs 9 months in operations to apply for one of Camino Financial loans
- Larger amounts of capital: You can access amounts of funding larger than what your family could probably lend you. Our business loans range from $5,000 to $400,000 to fit any of your business needs
- Possibility of graduating to a better loan: After only 9 months of timely payments, you can apply for a second loan for a larger amount and at a lower interest rate
- Exceptional customer service: You will receive the guidance of a business loan expert throughout the process.
- Continue education: Our services go beyond lending capital. We provide an educational experience that helps businesses improve their financial performance and grow their business. You’ll have access to tools, resources, and exclusive webinars.
Find out today if a small business loan from Camino Financial could be a more suitable option than borrowing money form your family.
All you have to do is submit this online application requesting a quote. You will instantly know if you are pre-approved, and this won’t affect your credit.
Soon after you submit your application, a business loan expert will contact you to guide you through the rest of the process.