Tribune Print Share Text

Investing in a family member’s business

Created date

July 23rd, 2013
Woman holding open sign
investing-family-members-business.jpg

In the still-weak job market, many people are choosing to start their own companies. At that same time, traditional financing is harder to secure. That means would-be entrepreneurs have to look to other sources for start-up capital. If you re retired with a sizable nest egg, adult children or grandchildren could approach you for money to launch a business. If you re in a financial position to help, forking over cash to help a loved one achieve a dream can be tempting. But, Henry Hutcheson, president of Family Business USA (familybusinessusa.com) says you should treat a family member s request for start-up capital like you would any other investment decision critically. Hutcheson says to consider your own opinion of the business idea s merits, your child s or grandchild s intelligence and work ethic, and whether other people are also willing to invest in the business.

Start with the plan

You should also ask to see a written business plan. Eric Erickson (businessattitudes.com), who provides consulting services to small businesses, says the business plan should clearly explain how the business will operate, how its product or service will be superior to those of its competitors, as well as the potential barriers to entry into the industry. The financial aspect of the business plan should be concrete, Erickson says. When you re going out and asking for money, you need to be able to substantiate where every penny is going. If, after careful consideration, you decide your child or grandchild has an idea worth investing in, then you need to decide how to structure your investment. Erickson recommends taking an equity position in the business, which can give you more control than simply lending the money. If someone wanted to borrow money from me, I would want 51% of the business, and once you pay me back, I would lower that equity position, Erickson says. Iowa financial planner Derek Tharp (motewealth.com) says he prefers to see family investment structured as debt. It can be much easier to unwind debt than complicate a family relationship with shared equity, Tharp says. The key to any agreement, however, is to have attorneys put all terms and conditions in writing and adhere to them strictly. If you decide to make a loan to a family member, remember that it is a loan, which means you should be paid back with interest. It s perfectly fine to offer a lower interest rate than your child or grandchild could get from a bank, but resist the urge to waive interest altogether. If you do, Tharp says the cash could be viewed as a gift, and therefore subject to a gift tax. Once you ve contributed money to a business, you might feel entitled to be involved in the day-to-day operations. While you might request periodic financial updates, Tharp says not to get involved in running the business. There is one exception: if you ve got an expertise that could be valuable and your child or grandchild has asked for your help. meghan.streit@erickson.com

Comments