Another method of shoestring start-up is to borrow from family and friends, but the arrangement can become difficult if problems occur with the loan, some business owners say.
Based on an article, “Starting up on a shoestring” guide are some suggestions to keep business from ruining relationships and three rules to follow when borrowing from those closest to you:
– Forget a straight forward loan and tie the financing to equity.
This is tough for most entrepreneurs, especially bootstrappers, who avoided traditional investment in the first place to maintain control of their companies
As U.S. Computer Group founder Stephen Davies told the article:
“The toughest thing is making a conscious decision to accept dilution of your ownership in order to get the capital you need. But when you’re seeking money because you’ve exhausted other cash resources, instead of simply to pursue growth opportunities – you’ve got very little choice.”
– If you do decide to borrow from someone you know, sign a promissory note just like you would when borrowing from a bank describing a schedule for repayment plus interest.
The three basic choices here are:
1. Equal monthly payments – The same idea as financing a car paying back a fixed amount over a certain period including interest and principal.
2. Equal monthly payments and a final balloon payment – You start out with lower monthly installments and pay back most of it at the end.
3. Interest-only payments and a final balloon payment – You pay the interest in installment and the principal at the end.
Three rules to follow when borrowing from family and friends, according to Charles Bodenstab, president of Battery & Tire Warehouse, St. Paul, Minn.:
1. Give each contributor a letter acknowledging the loan or investment
2. Pay an attractive interest rate (Figure in what it would cost to get the money elsewhere or be late paying bills)
3. Include a provision for paying the money back instantly upon request (This will be hard for bootstrappers who need the money to get started but certainly would go a long way in establishing trust)
You may have heard growing up as I did that mixing business and family relationships can be a recipe for disaster.
It’s a fact, however, entrepreneurs, particularly bootstrappers, seeking to avoid more conventional outside funding, have often used this form of financing successfully. Also, there are benefits to both borrowers and lenders in this relationship and that family problems connected to the loans can be avoided with proper planning.