Use caution with family loans for your business

Tips For Small Business

August 10, 2008|By Stephen L. Rosenstein

For many small businesses, bank loans, venture capital and money from angel investors are financing long shots at best. It is far more common for a small business to secure funds from family members or even friends.

Availability is the big draw. The downside is that business loans from family and friends also can be a disaster if they are not handled properly. Unstructured or loosely structured financing and pay back terms can haunt both sides in the future. Research shows that 14 percent of business loans from family and friends go into default, compared with about 1 percent for bank loans.

To increase your odds of success, approach family and friends with a detailed loan proposal just as you would a bank or venture capitalist. Be frank about the risks. If things go badly, they could lose all or some of their money. Consider the consequences of a soured business deal to your relationships.

Pick a financing structure that works best for your business and make certain everyone understands. Specifically, be clear on whether the deal involves an ownership stake in your business or whether it is a simple debt you plan to repay. Be clear about repayment terms.

Putting the terms of your borrowing agreement into proper legal form is crucial. You can find many different promissory note variations at www.findforms.com. Self-help legal publisher Nolo also offers forms and related information at www.nolo.com.

Stephen L. Rosenstein is co-chairman of the Greater Baltimore SCORE Chapter No. 3. Call 410-962-2233 to speak to a SCORE counselor or visit www.scorebaltimore.org. To send a question to SCORE, e-mail smallbiz@baltsun.com.

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