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Eve Tahmincioglu

Primary author Eve Tahmincioglu has been covering small business and entrepreneurship for more than a decade. She regularly writes about small business issues for the New York Times and BusinessWeek's SmallBiz magazine. She also writes the Your Career column for MSNBC.com. She is the author of "From the Sandbox to the Corner Office."



Beware of parents bearing loans

Posted: Tuesday, October 23, 2007 5:18 AM by Eve Tahmincioglu
Filed Under: , , , , ,

Ken C. Wisnefski describes it as a blessing and a curse.

This entrepreneur, who started business outsourcing firm VendorSeek in 2002, borrowed $100,000 from his father so he could grow the business.

STOP! Right now, I’m hoping many of you hear the scratch of a runaway needle on a vinyl record.

I’m sure you know how this story goes -- badly.

Why? Because money and family don’t mix. Trust me, I know of what I speak.

Okay, back to the story.


“We needed to expand," Wisnefski says. "Things were not growing the way I wanted and we were coming up short on capital.”

He was tapped out, including home equity loans, and the bank wouldn’t pony up additional credit.

So he went to Ken Sr.

His father agreed to give him the funds he needed but there was one stipulation -- his dad would become an employee.

His dad’s funds were a godsend. “The money saved employee jobs and the business from probable failure,” he says, “but it interrupted the dynamic of my relationship with my father.”

Never had the two men engaged in serious verbal battles in their prior relationship as father and son. But with the new dynamic, the battles were taking place on a monthly basis regarding disagreements in how Jr. was running the business. Even many of VendorSeek's 31 employees were starting to feel the tension.

There are no good numbers that show how often children borrow money from their parents to start a business, or help grow a business, says Bruce Phillips, senior economist at the National Federation of Independent Businesses’ Research Foundation.

“We used to say the main source of financing were the three 'F's: Family, Fools and Friends,” he quips.

I asked him if borrowing cash from parents was a good idea.

“It depends on how much they have. That’s the wise-ass answer,” he says. (I figured that.)

“Sometimes it’s definitely a no, because it can ruin a relationship.”

If it’s done at all, he advises, signing a promissory note after showing it to a lawyer, and establishing a payback schedule, just like a car loan.

You also have to consider unforeseen circumstances. What if you parents get sick, or lose their jobs and need the money ASAP. Talk about family fueds.

And don’t be lulled into complacency if you have everything in writing.

Just being asked constantly about the loan got to Jason Hanson, real estate investor and author of "How to Build a Real Estate Empire".
 
“When I first started my residential investment company I borrowed $30,000 from my parents for a pre-construction property. All terms of the loan were put in writing and both parties agreed to the terms," he explains.

But, (you knew there was a but) "after I received the money my parents constantly asked me questions about how the construction of the property was coming along, when were they going to get their money back, etc. I felt like a five year old child who was getting nagged every 30 seconds to make his bed.”
 
He ended up paying his parents back as promised but in hindsight, he says, the headache wasn’t worth it.

His advice: Don't do it

Ken Jr., who says his dad has done an excellent job, admits he'd do it all over again despite the hell.

But, he adds, “I probably would have set up a better understanding that ‘hey, it’s still my company.’”

Since his mother died six months ago, both father and son have “reevaluated how we’ve been acting.”

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Comments

What about when parents borrow money from their children?  How does that work out?
Lending to any family can be a disaster.  Parents, children, siblings, uncles, aunts, cousins...even putting it in writing doesn't mean much unless the lender intends to litigate.  The borrower knows that probably won't happen.  The expectation should be that the money won't be returned and the relationship could be permanently damaged.
There are a lot of things that can go horribly wrong on both sides.  I work for my in-laws, and fortunately with my husband & I, it's just been sweat equity. But... 10 years ago we resigned military commissions, took an 80% pay cut & moved in with them to consolidate expenses. In 10 years the company has gone from 500k revenue to over 15 million.  Two years before we joined my inlaws, they had my husband's grandfather co-sign a business loan where the bank required the grandfather to have an equity position. In-laws were desperate, so even though they didn't have a good relationship, they did it. Loan was paid off by their company, and ownership restructed.  Fast forward 12 years.  My mother in-law has a complete break with her father. Next thing we know we're being sued because the grandfather was never paid for his ownership.  He never actually put a dime in the business - simply co-signed a loan.  Well with the cost of litigation - blah blah blah - we ended up settling well north of six figures.  It can happen and obviously did to us!
Not wise, from personal experience.  My father, a pretty wealthy guy to whom a few hundred thousand, or even a few million for that matter, doesn't mean all that much, decided to invest up to $500,000 in $100,000 tranches over a 1-2 year timeframe in a real estate investment company. We had institutional investors for the equity portions of the investments and a pool of debt lenders for leverage, but needed working capital for overhead. We drew up legal paperwork with milestones in the business for the ongoing investments and gave him a very healthy interest in the business. He went in with the first 2 investments, then my stepmother found out about it, and as we don't have the best relationship, she was angry and decided I wasn't worth the money.  After  approximately 9 months, we went to him for the third slug of equity and, even though the business was going gangbusters (this was multi-family development in the northeast US-100+ units- in the late 90's, early 00's, so things were going very well) he pulled the additional funding.  We ended up being able to self fund it by draining our personal savings, retirement accounts, and working a few fees into deals (costing us much more in carried interest than was ideal for the first couple of deals) and have been very successful since, but my relationship with my father has never been the same and never will.  Be very careful if you decide to go this route, even if your parents are of the very wealthy class and you think you're doing it all by the book legally and ethically.  It can just make Thanksgiving and Christmas dinners, or the lack of, very difficult.  
Borrowing money from family memebers should be avoided if at all possible not only for business but for any other reason as well.  When it's for a business the risks are often higher but even for other reasons, it can cause strain on your relationships.  Plus there are so many other avenues for borrowing money (banks, government, etc.) that family should really be a last resort.
My father insisted on "loaning" me the money to start my business, but only a small amount that he could afford to risk and I would be able to repay - no matter what happened to the business. When it comes to raising additional working capital, I am on my own. I prefer it this way! Every business owner needs to ask themselves this question: "What happens when my business goes sideways?" - if you're considering borrowing capital from family. If you don't have a good answer to this question - you shouldn't borrow from anyone, especially from parents or family members.
When it comes to borowing money....We all my fel a little weary. If you have a solid business plan that is profitable without ripping of your customers.....then It would be a good idea. Click on the link read about an example
http://www.yelp.com/biz/vendorseek-com-mount-laurel


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