Thinking Of Borrowing Money From Friends Or Family?

This may come as a shock to you but in my experience over many years and in many situations, I’ve seen friends and family frequently co-sign notes, lend cash and lend credit cards, and while the best intent is always present, these loans frequently don’t get repaid. Actually, most do not get repaid. Unfortunately, this creates many problems and frequently deteriorates relationships. One wonders if a loan is worth the personal loss. I propose the following five “loss mitigation” tips:

1. First, resist the temptation to borrow from friends and family if possible. The odds of failure are high and with failure, the loans cannot be repaid. Even if failure is not the issue, businesses are often run at break-even or below and any growth and development eats up excesses. Loans frequently do not get repaid for a wide variety of reasons all ending up with insufficient liquidity to include personal debt service to reduce notes owed to friends and family.

2. If you do borrow, document everything with a note and hopefully UCCs for collateral or perhaps a subordinate second mortgage. This protects both parties – you and your lender – and stands as a barrier to other creditors wanting to collect. Such paperwork and filing does protect the ones you want to protect on a priority basis if things go bad and liquidation is the order. Make certain it is not a verbal agreement.

3. Assign a reasonable interest rate to the note as certainly the lender is giving up interest he could be earning on the money he has lent you. This is not profit but merely recovering his expenses and lost opportunity. Do not be afraid of loading the interest up a bit. Why not? Despite being friends or family, they are taking a risk and should benefit from this exposure.

4. Please put in writing a clear explanation of the risk and the absolute possibility of the business going bust or the possibility of the business lasting but being unable to repay the loan. Have the lender sign off on this memo indicating that they have a clear understanding of the situation.

5. Discuss and agree what will happen if the business does go bust. Decide now exactly how this will be dealt with and write a memorandum initialed by both sides so a clear understanding is memorialized and then both parties can live with the results.

Hopefully, debt service will be forthcoming and all will work out. If not, the understanding and agreement covers the possibility of default and the lender is adequately protected and understands the risk and potential for loss. Do these things and it is entirely possible you will preserve the relationship between friends and family willing to lend to you and your venture.