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Choosing between a bank or family loan

Our expert breaks down the pros and cons of these two borrowing options.

Feb 17, 2012 13:00 pm

Q: I am a new entrepreneur and I’ve been getting negative feedback from banks that refuse to lend me money for my business unless I had a track record. Would it be wise to borrow money from friends and family instead?

[related|post]A: If you are a startup business and it is your first time to venture into entrepreneurship, it will be advisable that you finance your business on your own. You can use your own savings, and maybe your credit card to some extent, to start the business and see if your business is feasible.

 

Own money. When you use your own money, you will be more careful and focused on making sure that your business becomes successful. And if it doesn’t succeed, at least your loss will be limited and manageable. You need to know how much capital you would be willing to invest and how much loss you could tolerate before you decide to close your business down.  

Now, if your business has survived at least the first six months and it has shown to be self-sufficient in terms of cash flow—meaning the business can sustain itself by using the cash inflows it derives from revenues to pay all of its cash outflows—it may be a good time for you to consider expanding.

 

Family and friends. By this time, it would be easier for you to pitch your business because you have something to show that is actually operating and profitable. Your family and friends will be the easiest to approach for funding because they are comfortable to deal with. Obtaining loans from them will also be cheaper compared to banks or outside investors.

Of course, because of your familiarity and comfort with these people, there is always a temptation to take them for granted. As an entrepreneur, you need to be professional in your dealings. You should treat your family and friends like any other investor. If you need to present a business plan about your business to other investors, then you should also do this to your family and friends. When they lend you money, you should document it under a formal agreement stating the terms and other details of the loan. For all we know, they may be your only source of external funding if you don’t qualify for a bank loan, so treat them professionally.

 

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