Why Borrowing Money From Your Friends Could Be a Good Idea

Published February 12th, 2018 - 11:50 GMT
Borrowing money from friends is not different from asking for a loan from the bank. Here are tips to guide you. (Shutterstock)
Borrowing money from friends is not different from asking for a loan from the bank. Here are tips to guide you. (Shutterstock)

Should you ask friends and family for money to start your small business?

Unlike men, women share a very simple and basic relation with their friends. They intentionally share the pink from their lives and keep the green buck away. Without touching the 'if' of this subject, let us do a rain check on why and how to borrow money from your personal resources.

Borrowing money from friends is not that different from asking for a loan from the bank.

Like most of us, you are probably reluctant to ask friends and relatives for money. But, at one stage or another, a lot of people borrow when they are running their own businesses. If you are really serious about starting and/or staying in business, you must swallow your pride and ask for those funds, as these funds come with a lot of privileges. Your friends and family know you and they will understand your difficult situations far better than a professional money lender. Generally, they are ready to help with more if needed, but this borrowing is extremely sensitive and calls for mindful engineering of the process involved in borrowing.

When asking your friends and family for money, be prepared to show your financial statements and make sure to prepare a written agreement. If your friends and family express an interest in assisting you with your business financing, then you need to pitch to them professionally. Don't be embarrassed to show a financial business plan, statements, tax returns or whatever else they want to see. Do anything to gain their trust in your business and earn that money.

You will want to prepare a written agreement about any loans. If you don't, bitter arguments are bound to sour the relationship eventually. Even some minor detail, such as the timing of interest payments, can cause great friction if arrangements aren't backed up in writing.

Don't be surprised when your friends and relatives suddenly turn into business tycoons once they have agreed to lend you funding. They may insist on terms that are more stringent than those you might get through a commercial bank.

Have I asked friends or relatives to lend me money? Sure! Was it fun? No, it was terrible. My cousin turned me down. He is a millionaire, but I didn't ask for charity. I wanted a loan, so he had to be the lender in his full totality. Did he consider my relationship with him? No, he didn't. He wanted full security for his money. So, he wanted to see my financials of the business. And to top all of these, his apprehension behind investing in a woman's idea was quite visible.

I did borrow a little money from my friend. Gosh, what a process that was. Seven rounds of meeting on the business plan, five different proposals to be my investing partner in my business and 25 days of convincing him that I just want to use his money for good and I shall pay him back every dime with the interest he wants. He had me sign documents, and, unlike the bank, had me send him interest every single month. If I was a day late, I could expect a call from him at even midnight.

My decision to procure a loan and not a partner was perfect. I suggest that if you are looking for a loan for your business, then try to get a loan, not an equity investment. This way, you won't dilute your ownership if the business takes off.

An investing partner or investing in your equity though relieves you of the monthly pain of EMIs but it's more than just that. A friend or a relative who makes an equity investment in your business, however small, is highly likely to tell you how to run your business, whether you like it or not. In addition, you end up in a messy discussion of what the true profits are and what expenses should or shouldn't be deducted before his or her portion of the profits is determined.

When asking your friends and family to finance your business, try to get a loan from them first, not an equity investment. But if the only way you can fund your business is with an equity investment, then go for it. Maybe you can get them to make part of it as investment equity to give them an upside and part of it as a loan to protect their downside, thus minimising the dilution to your ownership stake and the control of your business.

If you are taking external investors, it might be more appealing to them if you form a corporation, an LLC or a limited partnership. This way, they are not responsible for the debts and liabilities of the business if they make an equity investment and the business doesn't pick up the same way as expected.

Your friends and family are more likely to invest in your business if its corporate structure limits their liability. There are now companies that specialise in handling such transactions. They help with the paperwork and act as an intermediary for payments. This helps professionalise the process and it might be appealing to your reluctant rich uncle or an enterprising friend.

By Chanda Kundnaney


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