NEW YORK – Are you searching for money to start a new business? The first place entrepreneurs commonly look is their own savings or credit cards. The second place is family and friends.
Such private loans and investments from relatives and acquaintances are often an integral part of raising start-up capital, when a business is too small or unproven to qualify for commercial lending.
Entrepreneurs generally provide two-thirds of their own start-up capital. Private loans and investments make up the bulk of the rest, according to the Global Entrepreneurship Monitor, a consortium of universities.
The advantages are lower interest rates than at a bank (or none at all), flexible repayment and a certain amount of forgiveness if your start-up sinks.
But borrowing from relatives, or allowing them to invest in your new business, can put your personal relationships at risk, and the cozy nature of such loans can lead business owners to be lackadaisical about repaying the money.
The default rate for such friends-and-family loans is 14%, says Asheesh Advani, owner of CircleLending, which manages private loans; he is also author of "Investors in Your Backyard" from the Nolo do-it-yourself book series.
If there's one piece of advice to heed above all others, it is to put your financial arrangement in writing. Write a formal business plan, make out a promissory note and draw up a formal repayment schedule and stick to it. Such documentation cuts the default rate on private loans in half and makes it easier for both parties to claim their tax benefits, Advani advises.
Loans are far more popular than equity investments because they are cheaper and don't tempt an uncle or aunt to try to run your business. Advani says entrepreneurs pay an average 6% on loans from relatives.
Be honest with your lenders about what they're getting into. Most relatives will invest in your start-up for more than just altruism; they want to see you succeed, but they also want to make some money, too.
For information from the Small Business Administration on financing a start-up, writing a business plan and other guidance, go to www.sba.gov.