Planning to borrow money from family and friends? Follow this etiquette
When you start your own business, you will surely need capital. I am not talking about Rs 2,00,000 or Rs 25,00,000, the amount does not matter, it depends on your business. It is fairly obvious that you will turn to your friends and relatives. So, how should you go about doing this? Here are some tips you can follow:
Talk to them AND write to them. Tell your friends and relatives that you are going into business and need money, and ask for money. Some of us will find it very difficult to ask, so a letter or email may make it easier. Choose your options.
Tell them it is a risk lending you money. That is exactly why no bank wants to lend to you. You have no track record, no borrowing history, you are not sure of success, and 97 per cent of start-ups fail in the first year of operations. Yes, you need to couch it, but you should tell them this.
Your dad, uncles, aunts, cousins are the best source, so start there. If your dad says yes, be clear how much of it is a loan (debt) and how much of it is equity (repayable when able, or it could be lost). The debt portion has to be repaid from your future earnings (salary) in case you abandon this business. That needs clarity.
When a friend of mine borrowed Rs 1 million from his father, he still needed Rs 2 million to buy a shop. So he borrowed from a friend’s father (who also happened to be his father’s friend, and the amount was Rs 1 million). His father threw a tantrum and said, “If you lost Rs 2 million, I will have to pay my friend”. He will not ask me, but he is ACTUALLY lending to me, not to you, so please borrow more from me “and not from my friends”. Go create your own friends circle and borrow from them, not from my friends. This clarity is very important.
Ask them to give so much money that they can AFFORD TO lose without losing their relationships.
I lent Rs 50,000 (in 1990s) to a friend who was not capable of doing any business. I was stupid and naive. However, what hurt me was not losing the money, but the fact that he never got back saying it is lost. He is now doing very well, but has not even bothered to return the principal. This is criminal. You must communicate. Regularly.
Have it in writing. It helps in the income-tax hearing, if and when it happens.
Buy assets in the lender’s name. If you MUST buy a property worth, say Rs 50 lakh, and it is your father who is putting in the money, buy it in his name. And tell him that you will buy it back from him in, say, five years. That way, the only money that he is giving you is the rent that he is forgoing for five years, that is easier.
Tell them how you will repay the amount, or how you WON’T. If I invest in your business, say Rs 2 million, I want to know what you will do with the money. So tell the borrower how you are going to use the money. Tell him how you will repay. If you will pay interest, how much. In fact, if you wish to pay, say 12 years’ interest, just tell him that you will buy back his shares at double the price in six years. That is smarter than offering to pay interest; your cash flow may not allow that.
Your investor (big lender) also should know if things are going wrong. If at some stage you sell off your business, and can only pay a part of the principal, tell the investor/lender. He has a right to know from you and not from some other common friend. That hurts more.
Your investor invested Rs 1 million in 2016 and you had told him that you will repay it in 2023 as Rs 2 million. Great! This meant that the shares that you sold him for Rs 10 are being bought from him at Rs 20. He is a friend and was happy with that. Now in 2020, Softbank offers you fresh money at, say Rs 350 per share, but they do not want your old shareholders to stay on. You offer Rs 20 to your investor saying that instead of Rs 20 in 2023, you are pre-paying in 2020 itself, and that he is getting a great return. Of course, he saw the news item about Softbank willing to pay you Rs 230.
Figure out what will you do. NOW! Much before borrowing.
PV Subramanyam
Writes at www.subramoney.com and has authored the best seller ‘Retire Rich - Invest C 40 a day’.