The family business loan
What do you do when your children ask for money to start a business?
Authored by the Merrill Center for Family Wealth®
“Mom and Dad, I Want to Start a Business”
As a parent, you want to provide your adult children with every possible advantage on the road to financial independence. You want to prepare them for the challenges and responsibilities that come with managing wealth. But at the same time, you must be careful not to hamper your current liquidity needs, short-change your financial future, or (if you have more than one child) create an imbalance.
Just how much financial support should you be willing to extend when your adult child seeks help to become an entrepreneur? What form should that assistance take? And what structures should be put in place to avoid the all-too-common mistake of parental ‘over functioning’ which can lead to a corresponding ‘under functioning’ in your adult child.
At the Merrill Center for Family Wealth®, we recognize the unique and varied challenges faced by wealthy families and strive to provide insights and best practices for addressing these challenges as they arise. Our whitepaper, The family business loan: What do you do when your children ask for money to start a business, explores specific strategies designed to help you support an entrepreneurial adult child while requiring them to demonstrate accountability and a commitment to their business venture.
Parental support of this magnitude can take several forms – from a large gift in excess of the annual gift tax exclusion amount to co-investing in the venture in exchange for an ownership share or providing the adult child with an intrafamily loan. Each approach has its pros and cons (as well as legal requirements and tax implications). But regardless of which form your assistance takes, we recommend you carefully consider the following best practices:
- Require them to have ‘skin in the game’: If making a gift, think about offering to fund a portion of the needed capital but make the gift contingent on your child putting their own money into the venture. Or offer a low-interest loan, but establish clear repayment terms and hold them accountable to those terms. Sit down together and have an honest, open conversation about what you’re willing to do and set out a road map detailing your expectations.
- Use safe-to-fail experiments to better prepare them: Help the rising generation build needed skills and better prepare in their business endeavor by engaging in smaller controlled experiments where bad decisions or failures won’t be catastrophic. For example, perhaps the child wants to start a graphic design firm. Before making a major investment in launching and staffing the business, encourage them to first invest in the equipment they’ll need to spend 3-6 months freelancing for a larger firm to better gauge their passion and gain insights.
- Establish a support network: Young adults often don’t have solid support networks that allow them to launch successfully. In a traditional corporate career path, young adults have access to peers, mentors and leaders who can help them flourish. But for those seeking entrepreneurship, creating a network where they can access advice, inspiration and support might be more difficult. Encourage your child to connect with a professional development coach, attorney, CPA and financial advisor.
- Insist on clear structures and prerequisites: Think carefully about the role trusts, loans, gifts, and the like will play in your support of the endeavor. Solid structures (particularly legal structures) will be critically important in ensuring a sense of fairness and equity within the family. Additionally, make sure you sit down in advance and reach agreement as to specific actions and hurdles your child must clear as a prerequisite for your financial support.
Intrafamily Loans
One alternative to an outright gift is an intrafamily loan. While these loans require you to charge interest and document repayment, they afford you a great deal of flexibility in structuring the terms.
The loan can be for any amount and duration and there are no credit checks or collateral requirements. What’s more, you only need to charge a minimum required interest rate as set forth by the IRS (the Applicable Federal Rate). And this rate is usually well below the rates charged by most banks and other traditional lenders.
Entrepreneurship can be a phenomenal launching pad for your adult child to build independence, self-sufficiency and a renewed sense of purpose. Supporting them on that journey can be tremendously rewarding. Just be thoughtful regarding the amount and type of financial assistance you will commit to, as well as setting guidelines for obtaining that assistance. Make sure you’re all on the same page, communicate regularly, and be clear that you can’t be there to rescue them if things get difficult.
Interested in exploring this topic in greater detail? Read our “Family business loan” whitepaper for a case study that offers deeper insights, strategies and tips.
