Small Business Loans: Making a Loan From Friends and Family Work

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making-family-friends-loan-workEvery quarter the Graziadio School of Business at Pepperdine University, in conjunction with Dunn & Bradstreet Credibility Corp., publishes their Private Capital Access Index. Respondents are asked 40 questions concerning the availability of capital for their businesses, whether or not they were seeking financing, how successful they were at finding capital, and the source of the capital.

Although it’s not one of the first places the 3,573 respondents said they go to find cash to fuel growth, friends and family remain one of the most successful sources of capital for small business owners. Both larger and smaller small businesses accessed capital this way with 68 percent of those who successfully found capital in the third quarter reporting they found it from friends and family.

With that in mind, here are three things that will make borrowing from friends and family a little easier and make it possible to still attend the family reunion.

  1. Treat it the same way you would a bank loan—make your payments on time.  If you’re borrowing money from friends or family, you should be making regular payments—even if they initially suggest they don’t need it. Making timely payments from the beginning lets them know you take their relationship seriously and you won’t take them for granted. Create a schedule both parties agree to, and stick with it.
  1. Write it down. Regardless of whether it’s a loan or an investment for equity, make sure you capture the terms and put them on paper. Making a formal document is a great way to ensure that everyone understands the terms of the agreement. There are many websites that offer free loan documents you may want to consider, here’s one of them. There are also online services that will help you structure an agreement for your particular situation.
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  1. Follow the terms. Although this might sound obvious, if you commit to making a payment at the first of every month, make the payment. You should treat your family member the same as you would any other creditor. If they offer to defer your payments until “…you start making money,” you might want to make sure you understand what they define as “making money.” It could be different from yours. Regardless of what the terms are, if you keep your commitments, you’ll be able to attend the family reunion without fear of an uncomfortable confrontation.

Loans from friends or family members are often referred to as 3-F loans (friends, family, and fools) for a number of reasons—good intentions aside, sometimes obligations to friends and family get set aside for what is perceived as “real” business obligations. Don’t do it.

Borrowing from family and friends adds a level of complexity to the relationship that doesn’t exist with other lenders—or family members. Nevertheless, it continues to be an important source of capital for small business owners.

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