Family and friends are a reliable source of support for entrepreneurs. They can also be a valuable go-to source for financial assistance as well.
In fact, more small businesses rely on loans from friends and family than any other funding source. Familiarity with the person and his/her business goals, the investment opportunity and the ability to monitor the venture’s progress are among the major reasons why friends and family members willingly contribute to a start-up or expansion.
L-A SCORE counselor and treasurer Peter Sassano advises: “A ready source of cash is not without its potential pitfalls. Business loans from family and friends can also be a disaster if they are not done right. Unstructured or loosely structured financing and payback terms can haunt both sides later on. Research shows that 14 percent of business loans from family and friends go into default, compared to about 1 percent for bank loans.”
To increase the odds of success, approach family and friends with a detailed loan proposal, including financials from your business, just as you would a bank or venture capitalist. Be frank about the risks. If things go badly, they could lose all or some of their money. Consider the consequences of a soured business deal to your relationships.
Pick a financing structure that works best for your business and make certain everyone understands it. Specifically, be clear on whether the deal involves an ownership stake in your business or whether it is a simple debt you plan to repay. And be clear about repayment terms.
To legally seal the deal, use a document such as a promissory note. Putting the terms of your borrowing agreement into proper legal form is crucial. Go to www.findforms.com to find downloadable legal documents you need.
Sassano also recommends the resource Virgin Money at www.virginmoneyus.com, previously known as CircleLending.com before it was acquired by well-known entrepreneur Richard Branson. Virgin Money helps small business owners avoid the problems that can arise with loans from friends and family by providing loan administration, recordkeeping, payment processing and structural support.
To learn more about starting or building your small business, contact SCORE, a nonprofit organization of more than 10,500 volunteer business counselors who provide free, confidential counseling and low-cost training workshops. In the Lewiston-Auburn area, call L-A SCORE at 782-3708 for additional information and an appointment; in Rumford-Mexico call 364-3123; in Oxford Hills call 743-0499. Or contact SCORE at www.SCOREMaine.org.