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

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

    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.

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    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

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    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.

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    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.

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    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).
    Last edited by Harold Mansfield; 09-08-2015 at 03:17 PM. Reason: Solicitation. Please create a signature for yourself in the settings

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

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

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    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.

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    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.

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

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