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Raising capital to start or expand your business can be a major hassle. When getting a traditional bank loan or funding from venture or angel investors falls through, often people look to their family and friends for help after dipping into their own savings.
Borrowing from family and friends can be great on one hand because you can generally get flexible terms with how much and how you use the money; on the other hand, it’s also a risky proposition because mixing personal relationships with business can turn ugly, especially if the business doesn’t go as planned. Therefore, it’s best to be prepared with a plan before asking your family or friends for money.
Choose the right person
Deciding to borrow from family or friends is the easy part, but choosing the right person can be difficult. When making this decision, reflect deeply on your relationships with these people, especially when money was involved.
The worst thing that can happen is for your friend or family member to put a lot of stress on you to get the money back to them as quickly as possible. Moreover, if you decide on the wrong person then he or she may feel like they run your business even though you are only asking for financial help.
It’s vital to choose the right person to borrow from because it will set the tone for how your working relationship goes with your lender for what could be a long time.
Have a solid plan
When approaching your family member or friend, don’t simply ask them for money. Rather, have a firmly structured plan for how you are going to pay the money back. Just like with a bank or any other lender, there should be strict guidelines for how often and how much you will be paying back. Obviously, if you are a few days off here or there then hopefully it shouldn’t be a problem (unlike the late fees you can incur from banks and other lenders), but you should be able to show your friend or relative how you will be paying them back.
Also, offer to pay a modest interest as part of your plan (1% can be a good figure). While they are either related to you or a close friend, they are still going to be without a decent amount of money for some time and should be somewhat compensated for this. Depending on whom you ask, they may offer no interest, but it’s in good taste to plan on it anyways.
Make it official
Despite the fact that you’re borrowing from someone you inherently trust and inherently trusts you, there should still be something in writing to formalize the agreement. A handshake or a verbal agreement is not enough in this particular case. Plus, it offers protection to both of you in case something goes wrong.
For instance, if your business does falter then whoever lends you the money could receive a tax deduction for their efforts. This fact alone may also make it more enticing for a friend or family member to lend you the money and give them extra confidence that they’ll see their money again.
Borrowing from family or friends can be risky business, but if you take the correct steps and approach it with the right attitude then it can be a great idea to gain capital for your business.