Funding from friends and family

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Funding from friends and family

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Why should you read this guide?

Most businesses will need to borrow money at some time or another. If you are in a good position you will be able to do this from a bank or other lender. These lenders will only provide you with the funds if they are sure you will be able to pay it back. If you are not able to get this from any commercial lender then you will need to look at other sources. One of the most common of these sources is to borrow from friends or family. This guide will help you to do this.

Background

Friends and family are a common source of funds for small businesses and especially business start ups. The biggest problem with them is that they can put a strain on a relationship, as these are usually done on an informal basis. It is important to treat this as a business transaction and document this transaction for the benefit of all parties.

Making the approach

One of the biggest questions is who do you ask? You will presumably know who has got sufficient funds to lend you the money required. Just because they have the money though does not mean that you should ask them for it. You need to consider if you will be happy working with this person because effectively that is what you will be doing. They will suddenly have a vested interest in your success and will be within their rights to constantly ask you how things are going. Make sure that you find someone that you will be able to work with and set boundaries right at the start on how much involvement they will be allowed.

Loan or equity

Will you be asking them to lend you the money in return for a regular or lump sum repayment? If so then as long as you make the repayments then things should be fairly straightforward and they may not show as much interest in the business, letting you get on with the running of it. Another option would be to ask them to invest money in your company in return for a share of the company. This would mostly be if you were unable to guarantee making repayments to them. If this is the case then they may, quite rightly, want to have more to do with the business and making sure it is working well.

Documentation

Once you have decided who you are going to approach, what you are approaching them for and how you will be giving them the money back, write it down. This does not have to be some lengthy legal document. A simple explanation on what has been agreed will be enough. Remember to include:

How much is being borrowed/invested
When or if they will be repaid (equity investment does not guarantee a return)
What will they get in return - are you going to pay interest/dividends
How much involvement are they allowed in your business
What information will you give them on the performance of the business
What can be done in the case of a dispute

Once you have written all of this down it is a good idea for both parties to sign and date the document. Retain a copy each.

Tax implications

If the loan is interest free there are no tax implications. If the loan does accrue interest then you can deduct the interest payments against your profits for tax purposes. The lender does have to declare the interest as additional taxable income. If the advance is equity then you will not be allowed to deduct any dividend payment against your taxable profits and the investor will need to declare the dividend as income.

Summary

You need to treat this as a business transaction. The agreement should be documented and you need to ensure that all parties are going into the transaction fully aware of all implications. If you do this right at the start you have a better chance of a successful working relationship.

Further information

You can get more information on how to set up an arrangement from Business Link by clicking on www.businesslink.gov.uk. Tax information can be found on www.hmrc.gov.uk