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Borrowing money from friends or family  
Most small businesses get started with money from family and friends. It makes sense: these people know you better than anyone else, and are aware of your abilities and weaknesses. They will also want to support you in what you want to do (as long as your plans are reasonable!)
However, there are also potential problems attached to using 'friendly money'. Ignoring these problems might mean that your business comes at too high a cost: you might lose your friendships.
Here are some of the problems that you must plan to avoid:
Don't be too relaxed about financial agreements
When you deal with family or friends about money, they may feel awkward about discussing too many details. It's like a marriage: no-one wants to talk about divorce when they're getting married, but a marriage without a contract can get terribly messy when it breaks up (especially regarding money).
So, prepare a written agreement between you and the lender, and be as specific about everything as possible:
  • Exactly how much will you borrow?
  • Exactly how much will you pay back every month?
  • Which month will you begin repaying the loan?
  • What day of the month must it be paid? (Can you arrange a debit order?)
  • What if it isn't paid on that day? (Must you pay more interest or a penalty when payment is late?)
  • What interest rate must you repay?
  • What happens when the banks change their interest rate?
  • What if you can't afford to repay for a month or two?
  • What if you want to pay it back quicker than agreed?
If you can, get an adviser to help you talk through all the issues. A lawyer might be too expensive, but you could ask a mutual friend who is already in business or a financial adviser. Your bank may also be able to make a suitable person available.
Don't ignore the possibility of failure
In their enthusiasm to support your efforts, your friends and family may not realise the risk involved in your enterprise (after all, you will know much more about the details than they will). Or they may feel that they are being disloyal by suggesting the possibility that your plans might not work out.
The result is often that the possible consequences of failure are not considered, and you are left stranded when it happens. A business failure is not the end of the world, but is definitely a severe challenge for any entrepreneur - and is even harder if you don't have some plans in place to soften the blow.
These plans must include a way of dealing with the money you have borrowed. Unlike a bank, your family and friends may not try to take you to court for being unable to pay. But they need you to plan in advance how you will pay them back. Consider these questions, and make some firm plans that you can put into an agreement with lenders:
  • What if the business fails? (How will you pay the loan back without the business to help you?)
  • What kind of arbitration can you agree on in advance, in case you have a dispute about any aspect of the money or its repayment?
  • Will the lender have any say in how you spend the money within your business, or about how you run your business?
Don't ask friends for more than they can afford to do without
A good friend might be inclined to lend you more than they should. In other words, they might end up in dire straits if your business fails and you end up taking much longer to repay them.
Remember, you should be the one with the most objective assessment of the risks involved in your business. Unlike professional investors (who know how to assess risk and are very shrewd in their investments), your friends may be caught up in the enthusiasm of your venture and may not fully realise the dangers.
In the same way that you benefit from their trust in you, you need to repay them with caution - by making sure that they will not be destitute if you cannot repay their money as planned. Explain all the risks involved, and satisfy yourself that - if worst comes to worst - they will manage with a longer repayment schedule.
Don't leave them in the dark
As with any investor, keep your 'lender-friends' up to date with how your business is going. If possible, give them regular copies of your income statements, or even your bank account statements. Do this not just a courtesy, but as a way of getting feedback and advice about your financial progress. These friends may not have any formal role in your business (as directors or members) but they may have valuable ideas arising from what they see in your financial records.
Be open to their advice
As an independent, self-starting kind of person, you may expect yourself to have all the answers to your business problems. This is not realistic, and may prevent you from making the best decisions. Let others hear your challenges and suggest solutions; you don't need to always take their advice, but be open to it.
Consider being mentored
If you find that one of your lender-friends is particularly good at giving you honest and objective feedback, you may want to develop this into a formal mentorship role. Ask him or her if they would give you a regular hour or two a week - to assess the business's progress and evaluate how you are dealing with the challenges.
Having a regular opportunity to voice your ideas and concerns can build a more constructive relationship, instead of feeling that you are only running to someone when you've got a problem to solve. If your mentor has a loan in the business that he or she wants to protect, then they have an added interest in 'donating' some advice and feedback.