Ask an average small business owner the first point of contact, to obtain a business loan. Before mentioning local commercial banks and micro-finance banks, the response you will receive is;
“borrowing from family and friends”. When, there, even, appears to be affordable loan options in the former, small business owners still prefer the latter option.
Why do you think this option is preferable to others? The terms of lending are generous, the rates appears affordable, even, if you default on any set terms, they might not go through the route of making you pay dearly, after all, the circle is your family and friend and they would likely take it lightly with you unlike the banks and other financial institutions, that will fall back on the collateral, in case you default.
This is true, as you might be lucky to have wealthy family members, who would likely grant you unlimited freedom on how you spend the loan disbursed to you. On borrowing from family and friends, have you ever considered the return on investment of your lender, tax implications or the prospective role the lender might take in your business.
I have come up with a list of what you have to put into consideration, before accepting business loans from family and friends.
Approval is almost surely guaranteed
You may have a very diligent investor as a family member, or, a friend who may require a review of your business plan and confirming the credibility of your business, yet you will not be subjected to the same vetting standards that, most lending institutions, would insist you go through.
Getting approval from a financial institution needs both, a personal credit and strong business scores, with long years in the venture. When you are, even, going through the underwriting process, the rigorous activities involved, could take weeks, as your potential lenders would review your cash flow and current debt.
With a touch of your personal connection, you would likely be approved to obtain a family loan. Sourcing a family loan is a guaranteed method of securing capital at first go if the wealthy family member is willing to assist.
Generous Terms is likely guaranteed
The reason why small business owners prefer going through the route of considering a family loan, is the generous terms that you would have offered, compared to the one the bank would present.
For instance, you can obtain the exact amount of loan you requested for, low-interest rates or even obtain it, interest-free, ample pay-back time, as these can easily be sorted with your family, without going through the serious documentation processes that a bank would demand of you.
Do You Prefer Debt Or Equity?
When you obtain a business loan, you have just started a process of debt financing. You incur debt to get your business funded, while making plans to pay back the debt on agreed terms and conditions.
You could also go by the way of equity financing through obtaining funding as an investment. From here, your friends or family members would become financial partners in your venture, however, however, the decision to choose the kind of funding you prefer, lies with you.
If you have a family member who has some level of experience in running some strings of a successful business, you could bring them on board to get involved in the decision-making process.
Formality is still required
You might plunge head-on, in trying to obtain a loan from friends or family members, with the notion of making everything involved informal, in the hope of returning the money as promised.
There are, however, legal reasons you should make them formal, irrespective of the relationship that exists between you and the your family members and friends.
You need to ensure a high level of financial responsibility, by not taking their money for granted. You could always meet up with a legal professional, to assist you in drawing up the formal structure of the loan you obtained.
Personal with the professional
Obtaining a business loan from your family member means that, you are potentially combining your personal and business lives. It is all about the perspective you take into it. Some folks have the confidence that, they can easily manoeuvre their way through their family members and friends, in getting working capital. For others, they prefer it strictly professional.
Obtaining a loan from a family member or friend, can be a great avenue to see your small business scale, due to the flexible financing options available. It can also lead to some consequences that could mar your relationship with friends and family, if you default in repayment.
Ensure that, you keep your family members updated about the progress of your business and do not forget to keep your end of the formal agreement. With the way, you would go about researching loan deals, do the same, by speaking to your financial advisors.
It might be a family loan, but that does not make it easy, as you might likely encounter difficulties in paying back, due to familiarity.