How to loan money between friends.
September 5, 2013 2:24 AM Subscribe
A friend of mine would like to loan me £5000. I would like to accept his offer and do so with a fair arrangement to repay. Help?
A wealthy and business savvy friend of mine has been encouraging me to develop a business idea I've been working on for the last two years. It's a side-project to my normal work and as such has very slowly grown to become a viable product. It has now reached a point where it is ready to go but I simply haven't the funds available to bring the product to market. My friend is convinced I should proceed and has offered to lend me the £5K we estimated is needed to launch the business.
I would like to offer him favourable terms although the amount appears to be so inconsequential for him given his net worth. I'm just not sure what would be a fair arrangement.
I had thought either:
Loan to be repayable monthly over next three years at 5% interest.
Or...
Loan to be repayable in full after first year at 7%
What would you deem to be agreeable terms for a financial arrangement of this nature?
A wealthy and business savvy friend of mine has been encouraging me to develop a business idea I've been working on for the last two years. It's a side-project to my normal work and as such has very slowly grown to become a viable product. It has now reached a point where it is ready to go but I simply haven't the funds available to bring the product to market. My friend is convinced I should proceed and has offered to lend me the £5K we estimated is needed to launch the business.
I would like to offer him favourable terms although the amount appears to be so inconsequential for him given his net worth. I'm just not sure what would be a fair arrangement.
I had thought either:
Loan to be repayable monthly over next three years at 5% interest.
Or...
Loan to be repayable in full after first year at 7%
What would you deem to be agreeable terms for a financial arrangement of this nature?
Whichever you choose, make sure it's easy for you to make the payments and there won't be a lot of pressure to raise the monthly payment.
In fact, I'll go farther: since this is a good friend, and you're using the money to start up a new business, make the first year of the loan payment-free, so you can focus your energy and money on making it a *successful* business. (A business-savvy friend will understand and probably applaud that, since making a success of this new business will ensure you earn enough money to repay him!)
posted by easily confused at 2:35 AM on September 5, 2013 [2 favorites]
In fact, I'll go farther: since this is a good friend, and you're using the money to start up a new business, make the first year of the loan payment-free, so you can focus your energy and money on making it a *successful* business. (A business-savvy friend will understand and probably applaud that, since making a success of this new business will ensure you earn enough money to repay him!)
posted by easily confused at 2:35 AM on September 5, 2013 [2 favorites]
Assume the business doesn't work. Can you repay the loan in one year? Five? At that point, are you happy with the trade-off, or bitter that you are now indebted to a friend?
Can you structure it as a business investment (angel investor) instead?
posted by barnone at 2:36 AM on September 5, 2013 [1 favorite]
Can you structure it as a business investment (angel investor) instead?
posted by barnone at 2:36 AM on September 5, 2013 [1 favorite]
What interest would you have to pay the bank, and what would the repayment terms be?
I was going to suggest return on business but that becomes much more open to interpretation and destroying your friendship if it goes badly.
Set it up as a loan, make it as 'arm's length' as possible to remove the friendship element beyond the fact that your friend is willing to help you float this venture when a bank would probably not.
I also think that repaying a lump sum with a new venture is asking for trouble. Repay monthly, by direct debit. No thought required on either side. And make sure you can afford the repayment even if the business does not take off.
posted by koahiatamadl at 2:38 AM on September 5, 2013 [1 favorite]
I was going to suggest return on business but that becomes much more open to interpretation and destroying your friendship if it goes badly.
Set it up as a loan, make it as 'arm's length' as possible to remove the friendship element beyond the fact that your friend is willing to help you float this venture when a bank would probably not.
I also think that repaying a lump sum with a new venture is asking for trouble. Repay monthly, by direct debit. No thought required on either side. And make sure you can afford the repayment even if the business does not take off.
posted by koahiatamadl at 2:38 AM on September 5, 2013 [1 favorite]
Yeah, this is an investment not a loan. The problem is that an investment is more complicated, especially at this small scale where it's not likely to be worth actually creating a legal entity for the business until it has some revenue.
"Complicated" meaning your friend could have more tax or liability hassles from disclosing an investment of this type than an unsecured personal loan.
Still, if I were you I'd offer something like a percentage of your future revenues, either indefinitely or until 2x the loan is paid back or something like that. Something contingent on your success. And revenues not profit, it's a bit more arm's length and may not created all the same issues.
If I were him, though, I'd ask my accountant. And if he does and the recommendation is a straight loan, then I'd say no payments for the first year and then monthly amortizing payments for several years thereafter, no lump sum ever. Worry about the downside not the upside. If the business is successful and you want to talk to him about prepaying it early, that's a good problem to have.
posted by pete_22 at 3:22 AM on September 5, 2013
"Complicated" meaning your friend could have more tax or liability hassles from disclosing an investment of this type than an unsecured personal loan.
Still, if I were you I'd offer something like a percentage of your future revenues, either indefinitely or until 2x the loan is paid back or something like that. Something contingent on your success. And revenues not profit, it's a bit more arm's length and may not created all the same issues.
If I were him, though, I'd ask my accountant. And if he does and the recommendation is a straight loan, then I'd say no payments for the first year and then monthly amortizing payments for several years thereafter, no lump sum ever. Worry about the downside not the upside. If the business is successful and you want to talk to him about prepaying it early, that's a good problem to have.
posted by pete_22 at 3:22 AM on September 5, 2013
When I started a business my investors lent money to the business, not to me. It was more organized and on a larger scale than you are contemplating, but the distinction merits some thought.
posted by ryanrs at 3:42 AM on September 5, 2013 [1 favorite]
posted by ryanrs at 3:42 AM on September 5, 2013 [1 favorite]
Why don't you offer him "non-voting equity" in your company? Then if the idea takes off, he gets a nice reward, and if it doesn't work, you're off the hook. Also, 5% is very low if your idea is at all risky. The advantage of giving equity is that he shares in the upside.
posted by esprit de l'escalier at 3:45 AM on September 5, 2013 [1 favorite]
posted by esprit de l'escalier at 3:45 AM on September 5, 2013 [1 favorite]
Response by poster: The projected / target net profit during the first year is around £20K, quite achievable I feel. If I was to offer equity based on that figure what percentage would seem fair?
posted by Callicvol at 4:00 AM on September 5, 2013
posted by Callicvol at 4:00 AM on September 5, 2013
Your friend is the one taking the risk, let him set the terms of the loan. Then negotiate, if necessary.
posted by empath at 4:01 AM on September 5, 2013
posted by empath at 4:01 AM on September 5, 2013
Can you not set up a limited company, and give him, say, 10% of the shares?
posted by derbs at 4:09 AM on September 5, 2013
posted by derbs at 4:09 AM on September 5, 2013
If this is a loan, and you are a reliable borrower, then fix an interest rate at something more than your friend would get from leaving it in a bank, but less than you would pay a bank to make you the same loan. 5% might be reasonable. You could pay off interest-only at the start to keep costs down, so at any given point you still owe him exactly £5k. After that period (say 12 months) you'd then begin to pay off the principal plus interest. That means you take on the bulk of the risk.
If this is an investment (that your friend is willing to lose if your company fails) then his risk is greater so the potential winnings should be greater and longer-term. You can structure this any number of ways, but generally you'd assign him some shares in your company. The two main types of shares are income shares, equity shares or some combination of the two (often both in equal measure).
Income shares mean that if you take £20k in profit out of the company, he gets some percentage of that according to how many shares he has, vs how many you have. Equity shares mean that if you sell the company or liquidate it, he gets some of that money according to his shareholding vs yours.
One way to value the % of the company that your friend should get is to estimate the value of the time you'll have put in (sweat equity) at the point where his £5k will have done its work. If you've put in £45k of work, then he's put in 10% of the total equity so might expect 10% of the company. But if you're then going to put in another £45k of work over the following year, then either he should put in another £5k cash, or expect a smaller share of the company from the outset. How small that is depends on the overall risk, and is open to negotiation.
If you're consistently making £20k a year profit, then the company might be worth, say, £100k, maybe more, maybe less. So if you were to have given your friend 5% of the company shares for £5k, then that £5k would get him £1k/year of the profit (before tax) for the life of the company, plus his £5k back when it's sold - a tidy little earner in that case!
posted by cogat at 4:49 AM on September 5, 2013 [2 favorites]
If this is an investment (that your friend is willing to lose if your company fails) then his risk is greater so the potential winnings should be greater and longer-term. You can structure this any number of ways, but generally you'd assign him some shares in your company. The two main types of shares are income shares, equity shares or some combination of the two (often both in equal measure).
Income shares mean that if you take £20k in profit out of the company, he gets some percentage of that according to how many shares he has, vs how many you have. Equity shares mean that if you sell the company or liquidate it, he gets some of that money according to his shareholding vs yours.
One way to value the % of the company that your friend should get is to estimate the value of the time you'll have put in (sweat equity) at the point where his £5k will have done its work. If you've put in £45k of work, then he's put in 10% of the total equity so might expect 10% of the company. But if you're then going to put in another £45k of work over the following year, then either he should put in another £5k cash, or expect a smaller share of the company from the outset. How small that is depends on the overall risk, and is open to negotiation.
If you're consistently making £20k a year profit, then the company might be worth, say, £100k, maybe more, maybe less. So if you were to have given your friend 5% of the company shares for £5k, then that £5k would get him £1k/year of the profit (before tax) for the life of the company, plus his £5k back when it's sold - a tidy little earner in that case!
posted by cogat at 4:49 AM on September 5, 2013 [2 favorites]
A few more things:
Note that you can also buy your friend's shares back from him at a later date. In my last paragraph above, his equity shares are worth £5k and his income shares are worth £1k/year. So you could buy them off him for some amount above £5k in order to recover full control of the company.
Also bear in mind that shareholders' agreements are time-consuming and costly to prepare - £1k+ is not uncommon. So probably not worth doing for the amount in question - £5k definitely feels more like a loan than an investment.
posted by cogat at 4:57 AM on September 5, 2013
Note that you can also buy your friend's shares back from him at a later date. In my last paragraph above, his equity shares are worth £5k and his income shares are worth £1k/year. So you could buy them off him for some amount above £5k in order to recover full control of the company.
Also bear in mind that shareholders' agreements are time-consuming and costly to prepare - £1k+ is not uncommon. So probably not worth doing for the amount in question - £5k definitely feels more like a loan than an investment.
posted by cogat at 4:57 AM on September 5, 2013
2nd'ing keeping the transaction as arms length as possible but one thing to keep in mind...
I have some skills that I have developed in my current job (and other that I've developed from past jobs) and it makes me really happy when I can use those skills to help out my friends and family. My father-in-law has a big van and he loves to be able to lend it to his friends and family to help them move stuff. Most people have resources and they love when they're able to use them to help out their friends.
Your friend's resource is money and he's happy to be able to lend it to you to help you out. I get the sense that it might be a small enough amount (to him) and he wants to help enough that we would just give you the money if he thought you would be okay with that (and I get why you wouldn't be). So don't feel like giving yourself very favorable terms on this loan will be taking advantage of him. His joy at seeing you succeed is what he'll get out of it and that's probably worth way more than 5k to him.
If I were in your shoes, I'd set the interest rate just a shade over the average rate of inflation (~3% in the UK I think) and the term long enough for me to be extra comfortable with the payments. That way you won't stress out about having to make the payments, you can always pay him back early/faster, and he'll be getting back the equivalent buying power that he gave you.
posted by VTX at 6:46 AM on September 5, 2013
I have some skills that I have developed in my current job (and other that I've developed from past jobs) and it makes me really happy when I can use those skills to help out my friends and family. My father-in-law has a big van and he loves to be able to lend it to his friends and family to help them move stuff. Most people have resources and they love when they're able to use them to help out their friends.
Your friend's resource is money and he's happy to be able to lend it to you to help you out. I get the sense that it might be a small enough amount (to him) and he wants to help enough that we would just give you the money if he thought you would be okay with that (and I get why you wouldn't be). So don't feel like giving yourself very favorable terms on this loan will be taking advantage of him. His joy at seeing you succeed is what he'll get out of it and that's probably worth way more than 5k to him.
If I were in your shoes, I'd set the interest rate just a shade over the average rate of inflation (~3% in the UK I think) and the term long enough for me to be extra comfortable with the payments. That way you won't stress out about having to make the payments, you can always pay him back early/faster, and he'll be getting back the equivalent buying power that he gave you.
posted by VTX at 6:46 AM on September 5, 2013
Came in to say pretty much what VTX said. If your friend offered on his own and seems enthusiastic about the idea (and as you say can afford the money to play with) don't stress yourself too much about finding the exactly perfect terms, though my take is the 3 years and 5% is probably the best for a start up. Just make sure you can afford the repayments, with either an interest only period or by arranging a good rate. Your friend can always say if he doesn't like the terms you offer. Also if your business does crazy well there is nothing to stop you repaying him with a bonus or faster.
Also something to think about what plans do you have in place if the business doesn't go as well as you project. Most people I know that lend money would understand if situations change, but make sure you are in a position to pay off even a token amount regularly and to keep your friend in the loop if things do change. This could be important in keeping a friendship.
posted by wwax at 7:00 AM on September 5, 2013 [1 favorite]
Also something to think about what plans do you have in place if the business doesn't go as well as you project. Most people I know that lend money would understand if situations change, but make sure you are in a position to pay off even a token amount regularly and to keep your friend in the loop if things do change. This could be important in keeping a friendship.
posted by wwax at 7:00 AM on September 5, 2013 [1 favorite]
Oh hey I did this exact same thing a few years ago! (I was the loaner). Similar amount. I have a very strict policy about loaning money to friends but I made an exception because it was for starting a business, not helping him out of a rough spot (I might gift for the latter, but not loan).
We set the interest rate in between the highest interest rate I could get with a short-term investment and the lowest rate he could get from a bank loan.
We set the term at one year (paid in full) because that seemed easiest for both of us, with the option to revisit the terms and renew the loan on the anniversary date if both parties want to. We've renewed for 4-5 years now, with interest rates changing slightly according to bank interest rates (ended up being 3-5%). I asked for all interest to be paid every anniversary (assuming renewal), just to keep the loan amount consistent and to get a small amount of it back. We didn't do equity because that seemed kindof a hassle, and not something I needed.
I was worried about the possibility of his business failing but he promised to pay me back regardless, even if it took awhile, and I trust him to do that. It also wouldn't ruin my life to never be paid back.
So clearly these are all personal preferences and decisions, but that's my experience with a very similar situation, if that helps. No complaints with the process so far, although there is always the risk of not being paid back and that affecting the friendship.
posted by randomnity at 7:03 AM on September 5, 2013 [1 favorite]
We set the interest rate in between the highest interest rate I could get with a short-term investment and the lowest rate he could get from a bank loan.
We set the term at one year (paid in full) because that seemed easiest for both of us, with the option to revisit the terms and renew the loan on the anniversary date if both parties want to. We've renewed for 4-5 years now, with interest rates changing slightly according to bank interest rates (ended up being 3-5%). I asked for all interest to be paid every anniversary (assuming renewal), just to keep the loan amount consistent and to get a small amount of it back. We didn't do equity because that seemed kindof a hassle, and not something I needed.
I was worried about the possibility of his business failing but he promised to pay me back regardless, even if it took awhile, and I trust him to do that. It also wouldn't ruin my life to never be paid back.
So clearly these are all personal preferences and decisions, but that's my experience with a very similar situation, if that helps. No complaints with the process so far, although there is always the risk of not being paid back and that affecting the friendship.
posted by randomnity at 7:03 AM on September 5, 2013 [1 favorite]
cogat: "If this is a loan, and you are a reliable borrower, then fix an interest rate at something more than your friend would get from leaving it in a bank, but less than you would pay a bank to make you the same loan."
A good reference point for this would be the markets on Zopa or Ratesetter.
posted by turkeyphant at 10:07 AM on September 5, 2013
A good reference point for this would be the markets on Zopa or Ratesetter.
posted by turkeyphant at 10:07 AM on September 5, 2013
Is this a lot of money to you?
How long would it take you to save that same amount?
Does your friend want repayment, or does your friend want dividends?
If you can save up 5k in 5 months, maybe you should just wait, and bankroll yourself. If 5k is not an amount that you are capable of saving, maybe this is a bad idea.
posted by jander03 at 10:42 PM on September 9, 2013
How long would it take you to save that same amount?
Does your friend want repayment, or does your friend want dividends?
If you can save up 5k in 5 months, maybe you should just wait, and bankroll yourself. If 5k is not an amount that you are capable of saving, maybe this is a bad idea.
posted by jander03 at 10:42 PM on September 9, 2013
This thread is closed to new comments.
If you don't have 5k now, are you going to have it in a year if the business doesn't do as well as expected? However, it sounds like he has the 5k to play with, so why not structure the deal s.t. the return on his loan/investment depends on how well the business does?
posted by Metasyntactic at 2:31 AM on September 5, 2013 [6 favorites]