You may have shunned the bank by borrowing from family or friends, but you should still treat the loan as formal business. After all, borrowing money is not the same as borrowing the car.
To be sure you and your family and friends have a clear idea of what financial obligations are being created, you have a mutual responsibility to make sure everyone is informed about the process and decide together how best to proceed.
Drawing up a legal agreement can take some effort, and involves stating the particulars of the loan like amount, term, interest rate. It does, however, help to protect your relationship. You will also need to create a loan repayment schedule and to specify whether the loan is secured (that is, whether the lender holds title to part of your property or business) or unsecured; what the repayments will be; when they're due; and what the interest amount is.
Too frequently, business owners fail to take the time to formalise the paperwork when they borrow from family or friends. Often owner-managers put more thought into figuring out what to buy than how to structure this type of lending arrangement. Unfortunately, once you've made a mistake, it's difficult to fix.
It’s precisely for this reason that we have created Private Peer Loans; to give small business owners the opportunity to create their loan agreement, on terms that suit them, and to invite whoever they want. Loan agreements with rebuildingsociety.com are a regulated financial instrument, known as a 36H peer-to-peer loan agreement. These are eligible to be traded on a secondary market, which allows the inception lenders to sell their future repayments to new lenders, and also come with some tax benefits, such as bad debt relief and the option of inclusion in an ISA wrapper.
Formalising the loan agreement protects both you and your lender from HMRC. Relying on informal and verbal agreements results in tax quagmires. With a formal loan agreement, you have a burden of proof to demonstrate to HMRC that the money was not a gift.
If HMRC views it as a gift because there was no intention to repay it, then the lender becomes subject to the gift tax rules and may have to pay taxes on the money. Read more.
Any interest paid needs to be declared as income on a self-assessment. If the person lending the money is a higher rate tax payer, 40% is taxable. However, rebuildingsociety members may open an Innovative Finance ISA account to utilise their £20,000 annual allowance. Any interest earned from funds loaned via an ISA account are free of tax!
Once your agreement is in place, your responsibilities begin… Don't make assumptions or take people for granted just because they are friends or family members. Communication is key. To make things easy for you, each rebuildingsociety.com loan comes with a forum which allows you to have one place to communicate with your investors.
If your relative or friend is not actively involved in the business, make sure you contact them once every month to explain how the business is going. When people invest in small businesses, it often becomes a passion, so it's important to take the time to keep lenders informed.
And, of course, there are the repayments. Though friends or relatives may understand your business and the risks involved, you must never take the loan for granted. Don't be cavalier about paying back your lenders. That kind of attitude will abruptly ruin your relationships.
It helps to have an intermediary in place when times are tough. Having an agreement that allows you to make occasional interest-only repayments can really help with cashflow issues, especially since there are normally two months in any year when business performance is affected.
If the loan needs to be refactored to adjust the repayment amounts, or if a repayment holiday needs to be arranged, that can be quickly and easily facilitated online to change the repayment schedule.
Also, as your business grows, if the firm needs to borrow more than the family wants to lend, with a good repayment history you can promote your loan listing to a public community of investors to consider. Though you may face some tough questions.
Read more about the rebuildingsociety.com Private Peer Loans here.
