Borrowing money from friends and family to finance a new business is a terrific idea — in theory. Banks and other lenders will demand airtight business plans and financial statements. Your grandma Edna might demand a hug. But be aware of the potential drawbacks of so-called “easy” money.
If you allow too many friends and family to own a legal stake in your business, then you’re setting yourself up for trouble. Legally, you’ll have to run every major business decision by them first. And if you don’t consider their opinion, they can sue. Talk about an awkward family reunion.
That said, private loans can offer significant advantages over traditional loans. Interest rates — if interest is even charged — are generally much lower than those offered by banks. Private loans are also an important show of support (both financial and emotional) in the early stages of a new business [source: Advani].
Unfortunately, they’re also some of the hardest loans to get
One crucial rule: Get everything in writing. It will make both sides feel more secure about the transaction and rule out any potential legal problems down the road. You can find free boilerplate loan documents online.
There’s something romantic (in an economic sense) about financing a successful small business by maxing out your credit cards. We hear exciting stories about this all the time. What we don’t hear are the stories about new business owners who maxed out their credit cards and then failed. So before you turn to plastic for financing, consider the risk.
It’s true that credit cards can be a fantastic source for large amounts of capital. A credit card, after all, offers a line of credit with limits as high as $10,000, $20,000 or even $50,000 for a small business card. Since it’s a line of credit, you don’t need to fill out a loan application or submit a business plan each time you need an infusion of payday loans in Connecticut cash. Just swipe away!
Conceivably, you can leverage a debt of $50,000 with $50 monthly payments. But the question is, do you really want to?
A credit card allows you to carry a large balance as long as you make timely minimum monthly payments
The huge drawback of credit cards is that they carry very high interest rates. At the time of this writing, the average interest rate for a balance transfer credit card is 13.2 percent [source: Bankrate]. So if you choose to use a credit card for start-up capital, make sure you have a plan to pay it back quickly. If not, that interest will add up fast.
Bank loans are one of the most traditional and conservative ways to finance a small business. Small business loans are small beans for banks because they make a lot more money from big loans [source: [Consumer Reports]. But with the right attitude and the right business plan, you might get lucky.
A typical commercial loan from a bank feels a lot like a mortgage. There’s a fixed interest rate, fixed monthly or quarterly payments and a maturity date. The specific terms of the loan vary depending on whether it’s an intermediate-term loan (less than three years) or a long-term loan (up to 20 years) [source: Entrepreneur].
One reason why bank loans aren’t ideal for new businesses is that the bank will often require collateral or other existing business assets that it could seize in the event of a default. New businesses typically don’t have a lot of collateral. That’s why bank loans are better suited for construction projects, buying new equipment or expanding an existing small business.