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The Upside and Downside of Getting a Business Loan from Family and Friends

business loan from family and friends

If you have a new business and need finance to grow, you usually don’t have many options when it comes to business finance. Besides credit cards, business owners often go ‘cap in hand’ and call upon family and friends to get the business loan they need to grow. In fact, family and friends are one of the most common sources of funds for new businesses looking for finance.

Risks of getting a business from family and friends

If you are considering getting a business loan from family and friends, weigh the advantages and disadvantages. To avoid a bad outcome – such as dreading seeing your Uncle George or best mate from school at future social events – we’ll look at important points to keep in mind to ensure you don’t damage your relationships while building your business.

The good side of getting a business loan from family and friends

Getting a business loan from family and friends offers several advantages over using a credit card or traditional bank business loan. These include:

  • Not needing a strong credit history – if you have had credit issues in the past, you won’t need to show your credit report when seeking a business loan from family and friends.
  • Flexibility in making repayments – depending on your agreement, you can get more flexibility from a business loan from family and friends. They could also take an equity stake in your business if you get into a position where you can’t make payments.
  • Better interest rates – by getting a business loan from family and friends, you are more likely to get a better interest rate than from a bank.
  • No need for collateral – banks require collateral if you are getting a secured loan. This is unlikely if you are getting a business loan from family and friends.

Despite these advantages, getting a business loan from family and friends includes risks. Most importantly, if your business doesn’t work out and you have trouble repaying the loan, you could damage important relationships. In addition, you won’t build a business credit history with this type of loan. Having a credit history can be important for getting business finance in the future. 

Let’s look at some of the ways to avoid disappointment when getting a business loan from family and friends.

Keep it strictly business when getting a business loan from family and friends

If you want to keep good relations with your family and friends, treat the business loan as a business transaction. First, get a clear picture of how much money you need. A good place to start is with your business plan. If you don’t have a business plan, you should consider creating one or at least putting figures on paper that show how much money you need and what you will use it for. By going through the process of creating a business plan, you will be required to document your projected sales and expenses, and gain a sound understanding of how much money you need.

When it’s time to discuss your proposal, set up a meeting just like you would with a bank. Explain your business, product or service, and why you think your business will succeed and be able to repay the loan. Also explain the downside risks, including the things that could go wrong and make it difficult to repay the loan.

To keep the transaction strictly on a business level, create a loan agreement showing that the lender agrees to put the money into the business. The loan agreement should specify whether the business loan is secured (where the lender holds title to part of your property) or unsecured.

Agree on how the business loan from family and friends will be repaid

When it comes to repayment, there are many options to consider. One might be a payment schedule where you agree to pay fixed sums on predetermined dates. For example, fortnightly, weekly or monthly. Another option is to tie your repayments to your cash flow or income. This way you don’t end up needing to make a payment when you don’t have the funds.

Keep the lines of communication open when getting a business loan from family and friends

One way to ruin the relationship when getting a business loan from family and friends is to not communicate. Good communication doesn’t mean providing a business update when you see your lender once a year at a Christmas party. As creditors, family and friends will want to have regular updates on how things are going in the business. Effective communication could be a monthly email with updates on how you are tracking with your sales, expenses and profit. Staying the touch will put your creditors at ease and build their confidence in you and your business.

Consider offering equity interest in the business

Some family members and friends might want equity interest in the business instead of offering a business loan. This means they will own a share of the business, so they will share in the profits and losses of the business. Unlike a business loan, if your business fails, there is no obligation to pay the shareholder unless you have offered a guarantee as part of their investment. When looking for an investor among family and friends, it’s a good idea to choose someone who might be able to act as a mentor and offer assistance with a business. If your investor is a successful business owner, they will probably have helpful tips that can assist you in making your business a success.

Look at all other options before deciding a business loan from family and friends is the way to go

Getting a business loan from family and friends might seem like the easiest option when looking for funds but consider what else might be available in before deciding. If you have a small to medium business and don’t have an asset to offer as security, an unsecured loan might be the right choice. If you need funding in days, and don’t have months to wait for a bank to give you an answer, transparent and fee-free unsecured business loan could be the right option.

Get comprehensive information on business loans in The Complete Guide to Business Loans in Australia.

Author:

All the thoughts, ideas and musings from the Moula team! Covering everything from work/life balance to general finance tips plus everything in between!

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