Finding ways to fund your fledgling business is always difficult. Although there are many channels that you can go through, such as small business loans, it can be advantageous to approach friends and family for initial startup money. It worked for Jeff Bezos, who received $300,000 from his parents as an initial investment in Amazon.

However, borrowing informally from friends and family comes with several complications that should be considered before you make that all important pitch. Below is a list of the pros and cons of borrowing from friends and family when starting a business.

Pros

Flexibility

Loans from family and friends can be far more flexible than those provided by banks or other financial providers. With friends and family, you can organize a more flexible, and often generous, repayment plan.

For example, they may delay initial repayments for some time, or ask for interest-only payments for a certain time period. Some loans may be offered without any interest at all.

A Less Detailed Business Plan

It is always important to create a detailed business plan when setting up a business. Having a detailed plan ensures that all aspects of the business are understood and that the business is able to scale at a reasonable and successful rate.

However, when it comes to preparing a business plan for a family and friends loan, you may need a less detailed plan than you would when pitching to financial providers. This is because friends and family already know you, your character, and your financial and business situation. Therefore you save time and resources by not having to come up with a more detailed pitch.

It is, however, obviously important to be upfront and honest about your business plan and prospects when pitching to friends and family.

You want to be frank about the prospects of your business and the risk of investment. This will save any confusion, disagreements, or disappointments down the line.

Cons

Misunderstandings

One of the most common issues when it comes to a friends and family loan is the complications that can ensue from any misunderstandings as regards the terms of the loan (or whether it is a loan at all- you may receive the money as a gift).

Since the loan is more informal, so may be the terms. This is all well and good, but such informality can lead to confusion and upset if terms are not properly understood. It is not a problem you would encounter when going through official channels where terms are more rigorously laid out.

The lender may be expecting money back sooner than you expected, or be expecting a rate of interest that you were unaware of. This can lead to confusion and disagreement.

Damaged Relationships

Inevitably, the emotional stakes from a friends and family loan are much higher, since the lenders are your loved ones rather than professional financial lenders. And, as stated above, there can often be confusion and misunderstanding when it comes to giving and receiving informal loans. This can often be a recipe for awkwardness, arguments, and damaged relationships. What if you are unable to pay the loan back in time? What if you cannot pay the loan back at all?

Of course there are penalties when this occurs through banks, but with official borrowing methods there is less of an emotional burden if such situations arise.

A good way to allay this issue is to have everything down in writing. Make sure the amount, the rate of interest, the repayment plan, and penalties for non-payment are all securely in written form so that there is no confusion from either party. Honesty and clarity are the ways forward when it comes to receiving an informal loan. It will save financial and emotional trouble down the line.

By Sumeet Manhas

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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