Need Cash? Get By With A Little Help From Your Friends and Family

By Mike Drummond

You need to borrow money to start or expand your business, but the banks say no way. Who ya gonna call? Do what many of us have done at one time or another – hit up Mom, Dad or your circle of family and friends.

For many entrepreneurs, money from relatives and friends is the cheapest, quickest and most flexible source of financing available.

The pitfalls, however, are treacherous. Failure to repay can lead to awkward moments at Thanksgiving and ruin relationships. Ugly stuff.

That’s where Asheesh Advani and Virgin Money step in. Formerly CircleLending, Advani’s service sets up formal repayment procedures for so-called peer-to-peer business, real estate, personal and student loans. Want to find out how his service works? Read on …

How common is it for startups and independent product developers to seek funding from family and friends?

U.S. data show that 50 to 90 percent of entrepreneurs at some point get money from family, friends and their networks. Should they do that? It’s often a matter of necessity. It provides capital when others probably won’t be willing to. And it provides confidence and validity to your business idea. A lot of things we do at Virgin Money is help people with their credit histories. We service all payments like they were bank loans so you actually build a track record.

How are typical payments made?

Direct deposit. Direct deposit is always there. If there’s ever a need to change a payment, say they’re having a rough month with their business, unlike a bank we provide the maximum flexibility. We have the ability, with the lender’s permission, to move a missed payment to spread over the life of the loan.

Take a family member who says, “Here’s $25,000, pay me back in three years.” Well, it’s hard to make a lump-sum payment in the end. The discipline of a payment plan addresses that. Defaults drop by more than half when you have a payment plan. The default rate is 14 percent if you manage payments on your own. Most people when they manage their own loans start with monthly payments, but they typically become balloon payments. When we do it, we structure through direct debit and deposit, so it’s serviced automatically. Our default rates have never been more than 5 percent since the inception of the company.

What do typical loans among family and friends look like? How much money are we talking?

The least is say, you know, a couple grand. The most for a business loan is $2 million. The median is about $25,000. In the case of business loans, multiple lenders are quite common –from many friends or family with the same or different terms. It’s quite common to raise money from three to five people. Lenders don’t know what other lenders have lent and at what terms.

Why’s that?

They’re loans. It’s not an equity loan where everyone has the same terms. Your mom may have a no-interest loan, where a commercial investor has commercial interest rates.

How do you determine interest rates when borrowing from family and friends?

Everyone structures it differently. Right now for business loans it’s about 7.5 percent and about 5.5 percent for personal loans.

Hitting up family or friends for money can be awkward. What’s a good approach?

Lenders are more reticent about saying “yes” unless approached in the right way. Cracking that code opens up so many doors. The term I like to use is the ‘kitchen table pitch.’ Making the kitchen table pitch is different from the elevator pitch. There are some critical components. Do not prepare a long presentation. Family and friends want you to look them in the face and say, “Here’s what the risks are, here’s what I plan to do and here’s what I’ll do if it doesn’t work out.”

When do you recommend a gift vs. a loan from family and friends?

With small amounts, say $1,000 to $2,000, family members might want to consider giving it as a gift rather than lending the money. I will say the IRS frowns on giving more than $12,000. And in general, family and friends should consider small loans as something they may not get back again. That’s a healthy approach: If you only get back half, you can show it as a capital gains loss. That needs to be documented property, of course.

Visit www.virginmoneyus.com

About Asheesh

Asheesh Advani began his career as a management consultant at the Monitor Group, a strategy consulting firm, and subsequently worked at the World Bank in Washington, D.C. He founded peer-to-peer lender CircleLending in 2001, which Virgin Money acquired in 2007. He is the author of Investors in Your Backyard: How to Raise Business Capital from the People You Know (Nolo). He is a graduate of the Wharton School at the University of Pennsylvania and from Oxford University, where he received a Commonwealth Scholarship.

Kitchen Table Pitch

Unlike the aggressive “elevator pitch” you’d give to angel or venture investors, the kitchen table pitch to family and friends should be warm, informal and in keeping with the relationship you already have with them.

Make it comfortable

Pick a time and a place that suit the relationship you already have with the person. If you see the person regularly, you may be able to bring up your request in conversation. For others, it may be more appropriate to schedule an informal meeting – maybe over lunch or coffee.

Make it compelling

Communicate what most excites you about your business plan. Say why you think you’ll succeed. You don’t need to have a full-length business plan, but bring along a carefully chosen item, such as a sample product, a printout of your Web page or a mock-up of your brochure with a new logo that will impress your potential lender.

Make it safe

The two greatest concerns of private lenders are: 1) that the loan will jeopardize the relationship, and 2) that the money might be lost. Have a company such as Virgin Money set up and service the loan. It may take some folks a little while to warm up to the idea of loaning money to a relative or friend. However, having a neutral private loan expert can ease anxiety.

*Sample Pitch to Mom, Pop and Uncle Freddy

*Each option assumes you can afford monthly payments of $200 to $400, while enabling you to raise different sums of money.

Know This

Lenders can charge 0 percent interest, and some do. But because the law caps gifts at $12,000 per person per year, larger transactions between individuals draw special attention from the IRS. To prove that a loan is really a loan and not a gift, the IRS recommends charging the Applicable Federal Rate, which sets monthly minimum interest rates on loans between individuals.

Business Plan

Need help writing a business plan? Small Business Development Centers (SBDCs) and the Service Corp of Retired Executives (SCORE) can help. One-on-one counseling is available.

Visit www.asbdc-us.org and  www.score.org