One Fifth of Firms Rely on Friends’ Loans
Getting finance from friends is becoming a common first step for medium-sized firms that lack a track record, according to a 2024 Starling Bank survey. The study found that one-fifth of the businesses it queried relied on money from relatives or close acquaintances.
Why entrepreneurs favor personal loans
Unlike banks, personal lenders rarely demand high interest rates or extensive business plans. They are often willing to approve funds quickly, allowing founders to avoid the lengthy underwriting process typical of traditional credit facilities.
For many start-ups, the appeal lies in simplicity. A friend’s loan can be arranged with a brief written agreement, sidestepping the need for collateral or detailed financial projections that banks usually require.
In practice, the informal nature of these arrangements can also boost morale. Entrepreneurs report that enthusiasm from a trusted circle can be a powerful motivator, even if it does not replace the rigor demanded by venture capitalists.
Risks and safeguards
Despite the advantages, borrowing from close contacts carries significant hazards. The most cited concern is the potential strain on personal relationships if the business fails to meet repayment expectations.
Legal experts advise treating every personal loan as a formal contract. Clare Grayston, a corporate finance lawyer, says, “Raising money from family and friends is terribly tricky,’ argues Clare Grayston, corporate finance lawyer at Lewis Silkin, “and it has got to be a very grown-up process.”
Clear documentation should specify whether the contribution is a loan, a gift, or equity. If the funds are classified as a loan, the agreement ought to detail interest terms—even if the rate is nominal—to protect both parties and clarify tax obligations.
When equity is involved, founders must explain that investors could lose their entire stake if the venture collapses. A formal shareholders’ agreement can outline voting rights, pre-emptive rights, and exit provisions, reducing the chance of future disputes.
Professional advice is essential. Accountants can confirm that interest paid on a bona-fide loan is tax-deductible, while solicitors can draft agreements that meet regulatory standards without excessive complexity.
Structuring the deal
Entrepreneurs should clarify the nature of each contribution before any cash changes hands, documenting the decision in a formal contract.
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Written agreements must state repayment schedules, interest rates, even if nominal, and the purpose of the funds, ensuring tax treatment is clear.
Gifts exceeding a modest threshold could attract inheritance tax if the donor passes away within several years.
Long-term implications
Personal investors often lack the industry experience and networks that professional backers bring, which can limit strategic guidance.
Family members may feel entitled to influence business decisions, creating tension if their expectations clash with managerial autonomy.
Should the company later approach banks or larger investors, they will scrutinise the existing shareholder register and loan documentation.
Absent proper records, lenders may view informal arrangements as a red flag, complicating subsequent financing rounds.
After a public listing, companies lose the ability to directly update personal investors via informal channels.
Regulatory rules require public firms to limit communications, leaving former friends and family to rely on formal disclosures.
Many early supporters miss the frequent updates they once received, highlighting the cultural shift that accompanies a market debut. In conclusion, while raising money from family and friends can be a viable option for many businesses, it is key to approach this type of financing with caution and to ensure that all agreements are formalized and properly documented to avoid potential pitfalls and protect both parties involved.
