Borrowing money from family member to purchase existing business. Best approach

[ally567]

I have the opportunity to purchase an existing profitable business which is also a franchise. The only way I can purchase this business is to borrow money or ask my sister about investing. She would be putting in about 90% financially, but I would do all the work. The franchise fee is 9% and this business is profitable with growth potential. The existing owner lost the time she needed to run it and is busy with other projects. What should I do? If I just get a loan from my sister how can I be sure it's a good deal for both of us? Should I just have her invest? What's a good plan? The amount I need to borrow is 48,000 but the business has a potential of 65,000 annually.

[WPCarer]

How's your relationship with your sister?! You're asking her to put a lot into something that's a risk, but I suppose only you can decide if you still want to start up and risk your relationship with her. I know it could be an excellent opportunity for you both, but business with family is often risky. Do you have other options for getting a business loan?

Iseult

[Business Attorney]

There is obviously a big difference between loaning you money and investing in the business.

It is fairly easy to determine if a loan is a "good deal" for both of you. It's a good deal for both of you if it is more or less on the same terms that you would get a commercial loan. The loan should have a reasonable interest rate and a reasonable repayment plan, it should be secured at least by all of the assets of the business and should be personally guaranteed by you. The hardest part of that is to determine a reasonable interest rate. Loans for small businesses are difficult to obtain at any price if they are secured only by the assets of the business and a personal guarantee of the owner (that is, there is no other collateral such as a second mortgage on your house). I believe that an interest rate in the 10-12% range is reasonable if the business is not particularly risky. That is more than a bank loan but far less than if you were running up charges on a credit card. As the risk goes up, so should the interest rate.

Where the lender is taking 90% of the risk, the risk level of the investment is arguably more like equity than debt, particularly if the business has no significant assets that the lender can sell to recoup her investment if the business fails.

An equity investment is much more difficult to evaluate. On the one hand, if she is putting up 90% of the initial investment, one might argue that she is entitled to 90% of the ownership. However, since you found the opportunity and and will be doing 100% of the work, a reasonable percentage would be less than 90%. How much less depends on a lot of factors. Will the business pay you a reasonable salary for the work you do, before divvying up the profits, or will some or all of your effort be a "sweat equity" contribution to the business? If the latter, what is the value of your effort? If she is only putting up $43,200 (90% of $48,000), it doesn't take much sweat equity to equal or exceed her contribution.

Giving your sister equity raises many more questions than merely what is the appropriate profit split. As co-owners of the business, you would have to agree on a wide range of issues, hopefully by having a written shareholders agreement up front. You should never go into business with anyone without a well-thought-out structure. If you decide to go that route, find a good business lawyer in your area to help you set it up right.

[Harold Mansfield]

Do you know anything about running whatever business it is?
Have you ever managed a business or project of any sort?
You say this is a franchise, if they have training for franchisees would you be willing to take and finish the training as a condition of a loan or investment?
What's the business making now?
When will you start paying back a loan, and how long will it take to pay back with interest?
Also, where do you get the numbers that the business has the potential to do $65k annually?
And how do you plan on realizing that potential? And is this loan enough for you to grow the business..Marketing, Advertising, and so on?
Or is it just enough to buy the business without anything in reserve for operating costs?

These are the kind of questions that pop into my head and may be asked by your sister if she was considering it.

Just from what you've told us, it doesn't sound like a good deal for an investor or a loan officer. You want $48k for a business that isn't even making $65k. How much do you expect to make in salary to live? Are there other employees?

I know she's family, but you still need to go to her with a viable business plan that makes sense. Even if it's just verbal. She needs to know you've thought this out as a business. Not just arbitrary numbers and "I think, so gimme because I want this and you have the money to give me."

You're going to have to put together some real numbers of what it costs to run and what it actually clears.
It could be that this is a great business for the current owner as additional income on top of her other business interests.
But it sounds like you expect to make a living off of the business and with the numbers you've given, along with a loan payment, I don't see it.

Maybe you should run the actual numbers to see if this is really doable. You can't get anyone interested without real numbers.

[KnightNguyen]

As a financial advisor I can recommend that the way you should be approaching this is off a multiple for earnings. This should not mean the gross earnings but the net earnings. You need to review the financials to make sure the business is healthy enough to net a profit, and if it is not netting a profit look at the tangible assets (like equipment, product, et cetera) to determine the value.

In principle do not base your purchase off of gross sales, and a good ball park estimate for a franchise that is not at least 4 years old is 2.0 multiple on net profits (basically 2x2=4).

[veritasvisions]

Don't borrow money from family or friends. That's my opinion, I have tried lending out some money. It just won't work.

[Olson]

I agree with veritasvisions.Don`t borrow money from people close to you. This can affect your relationship for the worse.

[MXHeil]

A lot of advice here says don't do it, I would disagree and say you should both just know what you're getting into. Most businesses that get off the ground and land a physical location still fail within 5-10 years. Startups are the riskiest business there is. So if she decides to invest, she should do so knowing there's a strong chance she won't see the money back. If she loans you the money, go into that with the expectation that you'll pay her back whether or not your business takes off.

[SmallBizFinancer]

If you have a sound business plan and the risk to her money is minimal, I'd highly recommend that you take the money from her. Especially if she is laid back and not a "nervous Nellie".

And for sure, I'd rather borrow the money than have her own a portion of the business. The exception being if she brings effort or expertise with her.

Once the business succeeds, you can pay her additional thank you money. This is better than buying her out. Treat it as a surprise or bonus.

The only thing I recommend more than financing from Friends & Family, is either an SBIR Grant or money through a state or local economic development organization.

[Multimediatech]

Starting a business on a loan is just a perfect recipe for a disaster.

[Harold Mansfield]

Starting a business on a loan is just a perfect recipe for a disaster.

Unless you're Facebook, Twitter, You Tube, Google, Apple, Microsoft, General Motors, McDonalds, and just about every other successful business on the planet.
Yes, it's risky, but it's not always a recipe for disaster. The reality is that most people don't have the cash needed to start a business just laying around.

The abilities of the person running the business, product, market, and a solid plan have more to do with it than whether or not you're borrowing money.
Pretty much everyone borrows money in business. Even people who already have it.

[ArJol]

If I were to start up a business again, I would advise not to lend money from people who are friends or family members. I used my old accumulated loan for university studies which had a very low interest rate, to fund my first start up. But this was in Europe, not the US, so it might not work out so smoothly depending on where you live

[paul89]

I agree, I wouldn't also borrow money from my family and aquaintances. I would rather collect money every month, and then start my own business. All the best

[nealrm]

First, never borrow that type of money from a family member. Because until that loan is paid off, every family event will be strained. There will be questions about every minute that you are not working or taking a vacation. Also, should the business go bad, are you willing to live the rest of your life knowing that you lost $30,000 of your sister money. If she is struggling in retirement, are you willing to accept that???

I am assuming that she is an average person, if she is so rich she can just give away that type of money then the rules change.

I would also do whatever possible to prevent getting a loan. While that is not always possible, it is the best way possible. Don't listen to people that say only the rich start without a loan, that is BS. You may have to start smaller or wait a little while you build up the amount needed. But it is possible. Being debt free will also allow you to withstand market forces much, much better. People make foolish decision when under the stress of having to repay loans.

[Harold Mansfield]

First, never borrow that type of money from a family member. Because until that loan is paid off, every family event will be strained. There will be questions about every minute that you are not working or taking a vacation. Also, should the business go bad, are you willing to live the rest of your life knowing that you lost $30,000 of your sister money. If she is struggling in retirement, are you willing to accept that???

I am assuming that she is an average person, if she is so rich she can just give away that type of money then the rules change.

I would also do whatever possible to prevent getting a loan. While that is not always possible, it is the best way possible. Don't listen to people that say only the rich start without a loan, that is BS. You may have to start smaller or wait a little while you build up the amount needed. But it is possible. Being debt free will also allow you to withstand market forces much, much better. People make foolish decision when under the stress of having to repay loans.

I agree with all of that. Sometimes you have to wait. Build. Plan. Save. Get yourself in a better position to get started. Maybe start smaller.

Don't get caught up in the lie that all you need is a good idea and the rest will take care of itself. Too many people rarely think about what happens after you open. A month later. Year later. 3 years later.

MOST people who aren't in business for themselves, have no understanding of what it takes to create, run and grow a successful business. What they think they know is unrealistic. Taking loans from people who can't afford it, are looking for immediate returns, and do not understand that it's a risk and it may fail altogether is a disaster waiting to happen.

[nealrm]

Don't get caught up in the lie that all you need is a good idea and the rest will take care of itself. Too many people rarely think about what happens after you open. A month later. Year later. 3 years later.

That needs a line of exclamation points behind and change to bold 16 point text. Good ideas are a dime a dozen, maybe even cheaper. Doing the hard work of turning a good idea in something the turns a profit and you can live off, is a completely different point. Those willing to do that are few and far between.

[molinad31]

In most of the cases, yes, it's a terrible mistake. But I think that if you have a very small business with a year running from your own money, you are ready to recive a loan and you could manage it very well. I think that a business with 1 year old can be considered still a "start-up business." In my own opinion.

But yes, If you start a business with 0% knowledge and with a 100% loan = disaster/failure.


Greetings.

[LrenceM]

I don't think borrowing money to finance a business will succeed. There's a lot of risk in venturing into a business, and a lot of risks when the money came from a loan or a member of your family. I think you need to think more than twice before entering into it.

[TAAccounting]

Ally,

As an Outsource CFO - I would recommend looking at this very very carefully.

You are asking somebody to put in $48,000. Without knowing more - I am going to assume this doesn't have any working capital built into it.

The business has the potential of making $65,000 annually (is this Net Gain or Revenue?). I'm going to assume it's revenue and be conservative - which means the ROI on this business would be around 3%-5%. In short - not a great business acquisition.

A few other things you should be attentive to when purchasing this business - what are the relationship it has with its vendors/customers? Has the current owner neglected it to the point of no recovery (2 months of neglect can create 9 months of cash flow problem). Realistically, I would recommend getting an accountant to review this before you pull the trigger.

And remember - always be willing to walk away from a deal. If it's not a good fit, it's not going to be a good fit. Let me know if you would like my help on this one.

[John Blake]

I would definitely not recommend borrowing money from a family member without being 99,9% sure that it will succeed (you can never be 100% sure). Getting a loan may not be the perfect option, but probably slightly better. Remember to think twice (and maybe even few more times) before investing money and be sure that you know all the costs and risks that may come in your way.

[lacarrye]

Hi! @ally567,
I agree with KnightNguyen, before anything, make sure that you or an SME can review the financial statements and franchise agreement. Numbers are meaningless until you have a clear picture of the company health. As soon you verify that financial indicators are ok, you can proceed with the analysis of your financial needs. regards, J

[libra]

I take this opportunity to ask seniors here whether it is possible or feasible for a business owner to make a formal loan to his own company (eg. LLC) rather than directly injecting capital into it.

If yes, what would be the proper procedure to accomplish that?

[tallen]

Yes, it is possible. Write up a loan agreement between your person and your LLC that includes a re-payment schedule, make sure that the LLC is paying you a reasonable interest rate on the loan, but also make sure that you report that interest as part of your personal income on your personal tax return. At least that is how I would do it (I've always just made contributions of capital).

[libra]

Yes, it is possible. Write up a loan agreement between your person and your LLC that includes a re-payment schedule, make sure that the LLC is paying you a reasonable interest rate on the loan, but also make sure that you report that interest as part of your personal income on your personal tax return. At least that is how I would do it (I've always just made contributions of capital).

Thank you for your comments. Much appreciated.

I would then like to know also how direct contributions of capital is done, and whether this is preferable to taking a loan from oneself. Are there any pros and cons to it?

[tallen]

I would then like to know also how direct contributions of capital is done, and whether this is preferable to taking a loan from oneself. Are there any pros and cons to it?

You write a check from your personal bank account made payable to your business and deposit it in your business bank account. In the accounting system for your business, you would record this deposit as an increase in your owner's equity account.

To me this is a lot simpler than a loan -- you don't have to keep track of payments, interest, and the outstanding balance on an ongoing basis.

The con would be if you don't have the money available to make the investment, or you do but wanted to use it for something else -- in that case the loan might be better because you've obligated your business to pay you back on some schedule. Of course, assuming your business still has the money liquid, you could also take it back in the form of an owner's draw, distribution, or dividend (whatever you want to call it), but presumably the point of making the investment (or giving the loan) was for the business to spend that money to carry on or grow the business.

Loans might make sense if your business has multiple shareholders or members, not all of whom are ready to make an additional investment, and/or where reallocating the distribution of shares accordingly might be problematic.

[libra]

Thank you, @tallen for enlightening.

I was also thinking about when in case the business happens to be temporarily in the red, at least the loan repayments could still be in effect. What are your views in this regard?

[Darcie-amber]

My take is that Family and social relationships should never monetized in the form of lending and borrowing money. It can be treated and seen as financial abuse which for various reasons is illegal. I don't know, i guess it also changes the relationship to a business relationship and this can never possibly work with the resulting stress and friction in the event of an inability to pay.

[libra]

Thank you, @tallen for enlightening.

I was also thinking about when in case the business happens to be temporarily in the red, at least the loan repayments could still be in effect. What are your views in this regard?

Guess I will need to search on basic accounting theory on the Web. Thank you anyway for the previous answers.

[David Wilson]

How's your relationship with your sister?! You're asking her to put a lot into something that's a risk, but I suppose only you can decide if you still want to start up and risk your relationship with her. I know it could be an excellent opportunity for you both, but business with family is often risky. Do you have other options for getting a business loan?

I'm Totally agreed with his point, doing business in your family is often more risky and can be end up in disaster. However i would recommend you to shop around for second mortgages plan (https://snmortgage.ca/why-you-must-get-a-second-mortgage-in-toronto/). The hardest part of that is determining a reasonable interest rate. Obtaining loans for small businesses at any price is difficult if you are the owner of the property and have the enough equity maybe 20% or less in your property.

At the end Evaluating equity investments is much more challenging on another side she is holding 90% equity which means she owns 90% of the ownership and the main question arises is it a profitable business for you?