Have you ever been sitting with a family member and you were driving down the road, you start chatting about this week’s lotto 649 Jackpot, and how you would spend the millions if you won? Somewhere in the fantasy, the plot gets lost and instead of discussing the great things you could do, it leads to an argument about who owes who and why certain people should get more money, and why you should split it or spread it evenly even though it’s your ticket. All of this worry over a ticket that hasn’t even won yet.

The reason I discuss this, is that family is complicated and comes with history and hindsight. The discussion of money whether it is a fantasy $1 million or a loan for $10,000 comes with the expectations of how things should be according to your relationship. Sometimes these predispositions set the stage for future difficulties getting a loan paid back or getting a loan from a family member. It is often the unspoken that comes out around issues of money, especially if expectations have not been set. 

This is what we call a personal level relationship, but sometimes a personal level comes with all of the personal issues as well. Therefore, when getting a loan from friends and family, we suggest that you get the expectations out and make them clear. If it is for a small business you are starting, be clear that it is for a loan, short-term or long-term, or whether it is an investment/loan where they get a share in the business (active or inactive), or a mixture. This needs to be clear in the discussion, and leave no spoken word unwritten and or no unspoken promises not dealt with. Explain that money for small businesses is risk capital or love money, that the capital is literally the most risky part of the investment, but outline how the funds are going to be used so they feel comfortable with it. The golden rule of financing from friends and family is not to take more than they can afford to lose, especially if they are taking a loan to give money to you, be aware that this is NOT smart money and there could be regrets in the future if you are unable to cover at least the minimum monthly payments for their personal finances.

It was just a few nights ago I was at a BBQ and a family of 6 was sitting around having a glass of wine discussing one of the Grandchildren’s opportunities to purchase the restaurant he managed. The amount he needed was $200,000. The grandparents said they were in for $100,000, the one Aunt said she was in for $50,000 she would take out via her mortgage against her home, and that leaves $50,000 more he could finance with the Bank given that he is taking over with $150,000 in cash. While sitting in on the conversation, I was asked what I think. Firstly, the man’s experience in the restaurant industry has been impressive, the business had just made its first profits, but there needed to be an unbiased third party to analyse the business and accounts. The loans being made would need to be documented, and if the assets are unencumbered, I suggested encumbering them with the family loans so at least if a creditor were to come in the future, the assets of the business would be secured by those who love him. If the choice was to go with an unsecured loan, at least have a payment schedule in place and have the loan being paid down on month to month with balloon payments at year ends based on the success of the business. The one Aunt with $50,000 being taken from her home mortgage, I suggested she reconsider her financials and how that would affect her monthly payments. From the brief discussion we had, this was more money than she could afford to lose. I discussed with them the expectations, the Grandparents where happy to see the initiative, the Aunt wanted to be actively involved. How much of a reality is it all, it is a BBQ conversation, but that is often where the money is raised and the commitments are made. Make sure those verbal discussions get put into writing, and continue to put the discussions in writing, so that when the loan agreements are drafted and the discussions are there for back-up of the initial promises and expectations, good notes and good agreements make life easier for all. Treat these discussions like a Board Meeting, take minutes or notes, and file them aside. It is so important for clear communications. If it’s not written down, the conversation never existed.

That was just an example of some advice I had to give on the spot. There are more pitfalls that family has to consider, such as whether the person getting the funds is married or the chance they will. What clauses could be put in place to protect the investment? Are there other partners, should they be party to the loan, if they are spending/investing the funds on the family member’s part. If there is a partner in a business, get them on the loan too. I have seen many occasions where family lends capital to a grandchild or son/daughter, and the partner spends the funds with no consequence. If a business partner is not willing to go on the line for a family loan, one should reconsider their partners! Relationships begin as they will end, and the family will be treated with the last priority if they don’t get a commitment from both/all parties. That goes the same way for husband/wife loans; make sure as family both sign-on. There are volumes of case law that support this advice… always get both to sign.

When approaching friends and family for a loan:

1. They are more flexible
2. They may offer loans without security
3. They may lend interest free or low interest rate
4. They may allow a longer period of time
5. They are flexible on late payments
6. They already know who you are, and have faith in what they know

Remember from the advice and example given above about my friends at the BBQ and what I said to them:

• Write down the terms discussed and all prior meetings where money was involved in the discussion pertaining to a loan or investment
• Family will offer more than they can afford, don’t take it because you need it, be conscious of their situation as well. If they are borrowing to give you capital, be conscious of the payments they need to make at a minimum
• They will likely want to get involved with the business, make sure this is appropriate and welcome
• If there are partners or spouses, make sure it’s in writing with all parties not just the family member
• Define the expectations, make them clear, get it in writing and discuss and approve the accuracy
• Get the payment terms down, define the returns and timeframe, the use of funds, and overall involvement… then www.documentyourloan.com or www.kasu.ca can put the formal document together! This is a great service for getting it in writing.
• When it comes time to make an agreement at www.documentyourloan.com be prepared with the parties names to the loan, timing expected, interest rate, amount being lent. The software will calculate the payment schedule, including dates, amounts, interest, etc. You may want an addendum for how disputes and default will be solved.

To reduce the cost of a lawyer, I suggest using www.documentyourloan.com or www.kasu.ca and going over the agreement in place with a Lawyer who may decide to witness the document, advice, or add to it. In any event, it saves time and money.

If you do get the loan from www.kasu.ca and want to automate the payment from your account, you may want to discuss with your bank about filling out a direct debit form based on the payment schedule generated so that you can add an additional layer of security to the lender that they will be paid, and paid on time. Automation allows both you and the lender to sit back and relax.

I know what we discussed was friends and family loans and how it applies to small businesses and entrepreneurs, but other places and times you may ask for a friend and family loan includes:

• Consolidate debt
• Buy a new car, home, etc
• Capital uses such as equipment
• Home improvements
• Weddings, Funerals, Health Expenses, etc.

In some of our other articles, we discuss the matter of debt consolidation at http://www.documentyourloan.net/2009/11/debt-consolidation/ and http://www.documentyourloan.net/2009/11/consciously-get-out-of-debt-part-6-dealing-with-creditors-debt-collectors-consolidating-debts-and-paying-them-down/.

When you have great friends and family, you shouldn’t have to struggle through all the hoops of the old way of borrowing. Have a little ingenuity and faith in yourself to convince the people who do know and love you before you go to those who don’t.

Also if you are going to borrow money just think to yourself… www.DocumentYourLoan.com!

There may be many good tax reasons why you should make a gift a non-interest barring loan, as the write-off of the loan will give you a tax break where a gift may be taxed income. I do suggest discussing your loan agreements with a tax consultant.

If you need guidance or direction, email our consultants at info@kasu.ca. We would be happy to discuss your thoughts.