If You Borrow Money From Your Family, You Need To Do it Right… For Reasons You Are Not Even Considering.

Many small business owners borrow money from their family to support a business endeavor. It is natural and occurs all the time. Unfortunately, because it is family, it tends to be a looser, less formal transaction than if money is borrowed in the normal course of business, and loans of this type rarely carry a note or UCC filing, or even a written agreement.

It makes little sense to treat your family in such a shoddy manner as you are really sacrificing their protection if you ever get into financial trouble, and this happens every day. Most family lenders say, “I can trust so-and-so… I do not need a note or a UCC filing. My relative will pay me back.” It is not about trust between family members, it is about priority and payback, and protecting yourself and your family in a default situation.

Additionally, it is entirely possible (and even likely) that money may be borrowed from your family even before the bank lends. Thus, the family loan is on file in front of the bank’s, assuring your family priority in the case of default, which can be very helpful to the borrower for many reasons.

An astute banker or bank lawyer may require you to subordinate a family loan to a bank loan, thus removing the family from first position to collect. Though diluted, significant power remains if the loan is documented and publicly filed (and thus considered a legitimate obligation which must be respected and dealt with) and this can play an important role in the workout scenario. The bias of the lenders, bank and SBA is that a loan from a family member need not be respected or repaid, and can be ignored and rolled over for the benefit of the bank. Proper filing prevents such a cavalier attitude.

This is exactly what will happen unless the loan is documented, collateralized and publicly filed. This does not mean your family member will hard collect, or foreclose (or even collect at all), but it does create a barrier between the bank and your assets that may be very beneficial to your workout and survival, as well as making certain your relative’s money does get returned to them if possible.

The point being, if your parents’ loan for your new start-up is handled impeccably from the start, in default that will serve valid purpose as the terms are enforceable and thus it must be respected and dealt with. If not defined properly, it will be ignored, and not only will a loss occur, but you will have lost the protective benefit of such a filing.