Formal lenders are in the business of lending money. In order for their companies to survive, they need to minimise their risks, make sufficient profit to cover expenses and ensure long term sustainability. On the other hand, because family and friends believe in you and know you well, they simply want to know that you will pay them back (together with any interest that the money would earn) should they invest in your business. An added advantage of borrowing from friends and family is that the interest that you pay back on the loan stays within the family circle, instead of going to a financial institution.
Just because you are borrowing money from family or friends, doesn’t mean that you can skip the business details. In order to preserve your relationships it is critical that a formal loan contract is drawn up that contains all the details of the terms of the loan. This module outlines some of the preparation you’ll need to do in order to meet the expectations of the people who loan you money.
Often family and friends may not have the money you need, but can offer equipment. For example, they may have a car or a computer and printer, that you need to run your business. This loan also needs to be recorded in a business contract that clearly spells out responsibilities, costs and repayments. The other way that friends and family can help is by standing surety for your loan application. What this means is that you will not have to find the collateral money for the loan. However, you do need to be clear on that fact that if you cannot repay the loan, your friend/ family member who stood surety will be responsible for repaying the full amount plus any interest due! So once, again, this needs to be recorded in a business contract that clearly states how you will repay your friend/ family member in the event that the business cannot repay the loan.
Before you approach family and friends, you need to do the research and make sure you are able to answer all their questions and can clearly show how the additional items or money will grow your business.
The business case is an extremely important document as some friends or family may prefer to buy into your business and this document will help them understand the business and get a good idea of its value. In other words, if your family or friends wish to become equity partners in your business, you will both be working from the business case to discuss the equity options.
It is important that this document contains a section that discusses the possible risks facing your business and what steps your have put in place to mitigate them. The chances are that the people who can lend you money have a good idea about how businesses operate and they will be looking to see that you have covered all angles.
This option takes a little longer to get off the ground due to the number of people you need to work with. However, it can be a valuable way of raising money.
If equity is an option that the lender is keen to exercise, then shareholding details need to be included in this document. You will need to include the following details: Equity split, value of shares, the role of the investor in the business, return on investment and details of an exit plan.
In the case of a loan, details that need to be included are the duration of the term, the interest rate and the back-up plan for repayment in case your business struggles.
If the investor is standing surety for a bank loan, then this document will state the terms of the surety and the back-up plan for repayment in case your business is unable to honour its obligation to the bank. It is often expected that the surety is limited to the loan amount only and does not cover the bank’s interest charges.
Finfind provides its services free of charge to businesses seeking finance. Our primary purpose is to link SMEs with all the relevant finance providers and finance products that match their funding needs. As a matching service we are not required to be a registered finance provider as we do not loan money directly.