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Family

For many startup businesses, family and friends may be a significant source of funding. This is particularly true if there the personal credit history of the owner isn't strong and there aren't any significant assets such as real estate or an investment portfolio to collateralize a loan with.

Family and friends may invest in a business as investors, where they do not actively particpate in the management or running of the busines, or as partners where they do. It is very important that when a business is funded by family and friends that a formal agreement be written. The form of funding can vary, it could be a loan, it could be an equity investment.

If a family member or friend lends money to the business, IRS guildelines require that it be an "arms length" transaction. Your accountant can provide more accurate definition to these requirements, but generally there must be some term to the loan, payment provisions, and interest paid.

If the family member of friend is making an equity investment, they become owners in the business. Their personal credit will be relevant if the business seeks further financing from a bank. Again, it is important that legal documents be prepared that document the equity investment and the implications. For example, are they entitled to a share of the profits in porportion to their investment, or is there a different calculation?

Family and friends can be an important source of funds to get a business started but again, businesses are strongly encouraged to treat this as it would any outside funding an insure it is properly documented and executed.