So your friend has asked you to lend them some money for their business. What do you do?
A lot of people would tell you to steer clear.
It’s true, lending money to friends and family can have some big risks – not just financially but also socially and emotionally.
That doesn’t mean it’s never a good idea!
But there are definitely some extra considerations to make when deciding whether to lend money to a friend’s business.
Why Are They Asking You?
Asking this question could raise some red flags from the start.
Did they get rejected for a bank loan? If the bank thinks it is too risky, then it probably means it scores high on the risk scale.
Do they already have a bank loan but they still need more? If they are already in debt, that’s a risk in itself. What’s more, if your repayments are competing with the bank, then the bank will probably always be top priority.
You don’t want your repayments to be delayed or stopped because your loan isn’t considered as important.
Why Are You Considering It?
The next key question to ask is, why are you reading this article?
You’re seriously thinking about lending money to a friend. Why is that?
Is it because you think they have a genuinely good business idea and you want to invest? Have you looked into their financials? Will you lend to this business even if it wasn’t your friend’s?
If your answer is “yes” to these questions, maybe you have a good reason for considering the loan. If you really think the business will do well, you could also consider getting equity which is often more appropriate for high risk investments.
But if you’re thinking about it for a more emotional reason, you should proceed with caution.
Is it because you can see the business isn’t doing well and you want to help your friend?
Is it because you feel guilty for saying no?
Making financial decisions based on emotional factors is dangerous territory. The more you can take your friendship out the equation, the better it will be for both sides.
What Will You Agree On?
If you do decide to go ahead with the loan, the next step is to consider what deal you’re willing to accept.
Taking advantage of your relationship, your friend might ask for a lower interest rate or longer repayment date than what’s commercially acceptable. But you can’t get caught up in this special treatment – you should let them know that you want to keep the terms commercial and fair.
The best way to ensure you get a good deal is to speak to a lawyer. They can advise you on the key protections to include, and help draft up a strong loan agreement.
Getting A Loan Agreement
Yes, having your agreement in writing is crucial.
The last thing you want is for your friendship to deteriorate because each side had a different understanding of what was agreed.
The main legal document for lending money is a loan agreement. A loan agreement sets out the key commercial terms of the loan, as well as other important legal protections for both the borrower and the lender.
Having the agreement in writing means you have legal certainty, and can refer back to it at anytime to clarify any issues or concerns.
What’s more, if it all goes wrong, you know you have legal, documentary evidence of the loan.
What To Take Away…
Lending money to friends isn’t always a no-go, but it can be quite risky. It’s important to make sure your friend has legitimate commercial reasons for asking you for a loan, and that there are legitimate financial benefits and protections in place for you.
If you do decide to go ahead, seeking legal advice and getting a well-drafted loan agreement are the best ways to ensure a fair deal and minimise arguments down the track.
At the end of the day, you want your friendship to survive and that’s what matters the most.