Business Funding: Should You Get a Loan or Borrow from Family?

Business Finance 8 Sep, 2024

One of the most important considerations you have to make when you’re starting a business is where to get funding. This won’t be a problem if you have plenty of money to spend.

However, if you only have big plans but don’t have substantial savings to draw your funds from, your options are either borrowing from lending companies and individuals or raising money by asking from friends and family.

Business Funding Through Personal Network

Borrowing or asking money from relatives and friends to fund a business is common among young and novice entrepreneurs with wealthy connections. While banks and lending companies may hesitate to lend you money for a fledgling business project, your close friends and blood relations are likely to support you simply because they want to see you succeed.

Advantages

You can get the funds fast

As long as your friends and relatives have enough money to spare and they believe in you, they wouldn’t hesitate to give you the funds immediately.

If they give it to you in the form of a gift, there won’t be any legal documents to be processed. However, if it comes in the form of a loan or equity investment, you may have to spend some time discussing the repayment terms and legal agreements with them before finally getting the funds.

You might not need to pay any interest on your debt

If your relatives or friends lend you money to fund a business, there is a good chance that you won’t have to pay any interest. You simply have to return the money you owe in the agreed period. If the borrowed money comes in the form of a loan, however, your loved one may only require you to pay the principal or a little interest on your loan. This would make the monthly repayment more affordable for you.

If you’re getting the money in the form of equity, you won’t have to pay them until you gain profits from your business.

You can easily secure money from future investors.

Getting money from loved ones in the form of equity financing transform them into your business partners. However, they will likely be more forgiving of your business’ ups and downs than other investors.

Additionally, you’re likely to attract more investors to your company when they see that you are grounded in a network of loved ones who have already been convinced of your business plan.

Disadvantages

Albeit there are only a few disadvantages of borrowing or asking for money from your relatives and friends to fund your business, the risks are too great.

Debt of Gratitude

Even if your loved ones offered you the money in the form of a gift, some of them may expect repayment once your business prospers. A debt of gratitude is harder to repay because it cannot be quantified.

Sometimes, it can also take a toll on your business.

Strained Relationships

Meanwhile, if the business funding was provided to you in the form of debt and you could not afford to pay the loan within its term or make on-time payments every month, your friendship or family relationships might be strained. The same effect might also happen in making your friends and relatives your company investors. While some people can separate personal stuff from business issues, it’s not always easy for many.

If you’re one of those who find it difficult to share business decisions with other entrepreneurs regardless if they’re family or friends, make sure to put all the rules behind investment in writing and produce legal documents for agreements.

Do not forget to present a business plan where you lay out the objectives, goals and strategies for your business, including how to use the funds you raised.

Business Funding Through Lender Finance

Advantages

You can borrow a significant amount of money

Although you can also borrow a large sum of money from a wealthy friend or relative, this is not always a reality for many upcoming entrepreneurs. Most of the time, the only way to get a substantial amount of money for business funding is through a business loan.

You may not yet qualify for a million-dollar business term loan as a newbie business owner but there are other types of financing that you can explore, including small business loans, equipment financing and SBA loan.

You can fully decide however you want to use the money

While you need to present a business plan to convince a possible lender to grant you the funds you requested, they won’t meddle in your decisions after granting the funds. Their only concerns are the on-time monthly payments and the interest and full loan payment within its term.

Meanwhile, relatives and friends are likely to meddle in your financial decisions if they lend you money for business funding. This is especially true for those whose parents and close family members are business owners themselves.

You can keep all the profits to yourself

If your business prospers after taking out the loan, you won’t need to share your profit with the lending company. You simply have to repay the loan and its interest and that’s it. This is in contrast to having a family member or friend as an investor in your business. The profit that you need to share with them depends on how much your business is making. The more prosperous your business becomes, the bigger their profit share.

You can get a tax deduction

The interest accrued on your business loan is tax-deductible. This applies to term loans and business lines of credit where loans are solely used for business purposes.

Your business credit score will increase

With responsible payments, your business credit rating will improve. This helps you get business loans with better terms and lower interest rates in the future.

Disadvantages

Your credit history will be checked

Unlike borrowing money from a friend or relative, taking out a loan from a lending company follows a standard process of checking your credit records, financial circumstances and capacity for repayment. If you have a low credit score or do not have a stable source of income, you’re likely to get denied by the lending institutions.

You may have to pledge collateral

Most of the time, lenders may also require collateral or a personal guarantee to approve the loan. This involves the pledging of an asset as security for the loan, which means that the lender has the right to seize and sell your asset if you default on your loan.

You may not get the exact money you want to borrow

Sometimes, the lender may not also grant the full amount you requested but only about 80% of it. This can become inconvenient as you may still need to find money from other sources to raise enough capital for your business.

So, Which One is Right For You?

Raising money from your personal connections is only ideal if you come from a long line of business owners or friends with successful entrepreneurs who can provide you with enough business funding on top of soundly business advice.

If you can’t find one who can give or lend you money at reasonable terms, it is better to get financing from trusted financial institutions like banks or fintechs. These companies are licensed and regulated by the government to provide business financing while protecting consumers against predatory lending.