Friends and Family Financing is the means of receiving initial investment funds from close confidants – this means friends, family members, or co-workers. Family and Friends are great resources for startup funding because they are easy-to-find sources that tend to have less stringent payback requirements. Funding from friends and family is often limited and not the sole form of initial investment, although it is known as the most common startup financing route. According to a survey in the 2004 Inc. 500, half of the CEOs of the nation’s fastest growing companies stated that family was involved in regards to start-up capital.
Legal Issues
- Monetary Gifts: The IRS pays particular attention to family gifts because IRS rules state that you may only receive up to $13,000 each year from one person tax-free. Any amount over this threshold requires a gift tax return file submitted to the IRS – the giver will then be assessed a federal “gift tax” which is calculated at the same rate as an estate tax.
- Loans: To ensure and protect intrafamily transactions, it is a smart business idea to create a legal paper trail with promissory notes. A promissory note is a traditional signed legal document outlining a loan’s repayment schedule – its formal tone will set loan expectations, as well as encourage borrowers to successfully repay loans.
Deciding Loan Terms
There are some key issues that should be considered when discussing the terms of your loan. The promissory note should include, in detail:
- The names of the borrower and lender
- Payment frequency and timeframe
- Amount per payment
- Interest Rate
- Consequences of missed or late payments
- Offered Collateral
Loans from friends and family can be a good source of debt financing. In addition you may want to consider equity financing with friends and family. For more information see our blog post on equity financing with friends and family.