At its very core, a business exists to provide goods and services that are in demand for the sole purpose of turning a profit. But before you can start generating any cash flows, you will need to put up your own capital outlay to acquire the necessary papers, equipment, materials, and everything else necessary. As a result, using a wide range of financing options and debt capital on top of your personal investment in the business is a crucial step forward for anyone with plans to start their entrepreneurial journey.
However, circumstances vary from person to person, and one’s access to financing options can significantly differ from the next, meaning that specific terms might not be as agreeable or the amount they were hoping to get is far from what can be provided. That being the case, most people turn to their family and friends to borrow money and pay it back later when everything is settled, but this alternative is a lot more challenging to handle than most people realize.
Why Does It Happen?
To put things into context, while most people would typically approach a bank for financing options, one reason that may persuade them otherwise is a poor credit rating that will greatly impact their borrowing capacity. Furthermore, your credit history and current payment obligations will matter when deciding terms and interest rates, which might warrant more constraints than the actual buying power you gain from the acquired funds.
What’s worse, the current economic situation, in general, with stocks selling off alongside Bitcoin’s drop in price, it’s no surprise why a vast majority of people can’t squeeze out any extra funds for their business ideas—turning to friends and family instead.
What Are the Drawbacks?
While there’s nothing inherently wrong with borrowing money from friends and family, especially if you can keep things professional and strictly business, these types of agreements are more prone to fallout and unexpected issues in the long run. Specifically, you run the risk of damaging your close relationships or finding trouble dealing with limited legal protection when the situation changes and either creditor or debtor can’t maintain their obligation.
- Think About Your Relationship: Often, talking with a close friend or family member turned creditor can bring up some uneasy topics that you might want to avoid, such as spending habits, business plans, and many similar. And if you reach a misunderstanding on your loan that turns sour, it’s almost impossible for one side not to hold at least some form of resentment for the debtor’s failure to meet the payment schedule. As a result, your relationship may never be the same if you approach them as a financier.
- Misunderstandings and Legal Protection: Anything and everything can happen. One advantage that a bank provides is the assurance of reasonable legal protection if things go awry or if the obligation must be perfected earlier. However, in the case of borrowing money from friends and family, you don’t receive the same luxury in legal counsel unless you have the foresight and resources to invest in professional services. Consequently, the risk of lacking documents can cause some trouble with the IRS.
You Can Do It, but Be Extra Thorough
Of course, despite some of the drawbacks mentioned above, there are numerous benefits to reaching out to friends and family for lending, such as flexible pay, lower interest, and a few extra lender benefits. But for you to make it work means being thorough with the papers, namely settling all the stipulations through a signed contract, agreeing on a fixed and final payment schedule, and defining your exit plan.
- Settle the Details and Sign a Contract
Handshakes are good, but the risk of misunderstandings is near limitless, and therefore settling all the details upfront in a contract is the safest guarantee for both parties. Merely going off word-of-mouth is subject to faulty memories and subjective interpretation, so clear and concise terms are necessary. Plus, it’s also a great idea to seek out a reliable process server for the prompt delivery of legal documents.
- Agree on a Fixed Payment Schedule
Flexible payment schedules can work, but receiving payments haphazardly without any clear date to expect them creates more problems than it solves. So, to avoid unnecessary disagreements or put the creditor at a disadvantage, we recommend agreeing on a fixed payment schedule to keep the conditions uniform. This also makes payment tracking a lot easier and less difficult to manage.
- Define Your Exit Plan and Terms
No matter what the nature of an agreement may be, all deals should clearly define how investors will “cash out” their investments or loans. As a result, you must observe the same principle when borrowing money from friends and family to keep transactions smooth and prevent unexpected circumstances from affecting the loan. It also acts as a safety measure for both debtor and creditor.
If Possible, Always Use Family and Friends as a Last Resort
Nevertheless, even if it is possible to borrow from family and friends to help fund your business ventures, use this alternative sparingly and only as a last resort after exercising all other options. In fact, you might even want to try running your business debt-free because there’s a lot less risk involved which can guarantee more safety during these troubled times.