Family and Friends
The fact remains that the most common sources of funding for start-up, small businesses and entrepreneurs are from personal investment and funds generated through family and friends.
Business owners are reminded to look first at their own personal savings and then leverage of personal assets, such as home equity or investments. Many small business owners get access to additional capital by borrowing from or pledging assets owned by family and friends.
Most professional capital providers’ first look to see that the entrepreneur is "all in" and that those closest to the entrepreneur are backing the venture before he will consider an investment or loan.
Document the transaction:
- Although the initial funds may be generated from those closest to you, it is recommended that you treat the transaction professionally.
- For example, to avoid family strife and miscommunication, any capital infusion should be identified as to whether it is debt or equity, when and how it will be repaid and what the interest rate or return is. Simple loan agreements can be purchased at a local office supply store in the "Forms" section or samples can be found online.
A return on the investment is required:
- Even transactions between family and friends require a minimum interest rate, which is determined and published monthly by the IRS. When less than the minimum rate is charged, the difference may be imputed as additional income to the lender, which may be taxable. The borrower has a like amount of additional interest expense which, depending upon the nature of the interest may or may not be tax deductible.
- Many lenders neglect to charge interest on a loan to family and friends. Unfortunately, unless an IRS exception applies, the paper income and resultant tax could put a strain on a personal relationship.
Other personal loans & credit cards:
- Many entrepreneurs access personal credit lines and credit cards to purchase business basics such as supplies, meals, travel, even computer or telecommunications equipment.
- When possible, track the credit between personal and business needs by using separate cards. Begin to document the repayment and resulting business credit history by using company checks.
Creative use of family resources:
- By being creative, the entrepreneur can establish credit for the business early and maintain productive assets based on family financial objectives.
- For example, some entrepreneurs have access to family assets, such as certificates of deposit or stock which may be pledged as collateral for a bank loan instead of being lent or invested directly into the small business. This tactic usually requires an established deposit relationship with the bank and projections that show that the loan will be repaid through cash flow, not by liquidating the collateral.