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If a friend is starting a new business, they may approach you to lend them money. It is important to assess the amount of risk in these circumstances and whether you will be repaid. This article explores the legitimate concern of ensuring repayment when lending a friend money and ways to secure your interest.
Questions to Ask Before Lending Your Friend’s Business Money
Before lending a friend money for their business, there are a few things to consider by asking yourself the following questions:
Why are they asking you for money?
If they are approaching you for money, it is possible that the bank has already knocked them back. If a bank’s assessment is that lending your friend money is not a risk worth taking, then you should probably feel the same.
Alternatively, your friend may already have a loan from a bank but still need more money. In this case, it is crucial to consider the prioritisation of repayments. The bank takes the number one priority and so when your friend is repaying their debts you are at best their second priority.
Perhaps, the business is performing poorly financially, and they need your money to help them through a turn down in business. In this type of scenario, it is best to try and remove any emotions from the decision. Of course, you would like to help your friend, but you need to think about whether doing so is practical for you. For example, if you think it might mean that you will never see your money again, offering to help out in other ways may financially be a safer option.
Why do you want to loan them money?
If you think lending money to them is a good idea, be aware of their business’ finances and their future growth plans. If you are confident that you would provide the business with a loan even if your friend didn’t own the company, then you may want to consider investing in return for equity. Equity will provide you with more control and input in the future of the business.
What terms are you willing to agree to?
Your friend may expect you to offer them mate’s rates, but it is best to make it clear that you expect fair commercial terms. The loan should also provide you with a clear financial benefit. Remember that you are doing them a favour and lending money means taking a risk, so it is okay to expect a decent return. Having a lawyer draft the terms in writing through a formal loan agreement that both you and your friend sign minimises the chance of future disputes.
Setting Out the Terms of the Loan in Writing
To set the terms of the loan out in writing you will need to draft a loan agreement and include key commercial clauses found in a loan. These include provisions such as:
- the amount to be loaned;
- the drawdown date;
- the purpose of the loan;
- early repayment terms including potential penalties;
- default interest;
- termination options;
- the dispute resolution process; and
- whether the loan is secured and if so how.
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If you have come to a settlement on the decision to provide a loan to your friend’s business, it is a good idea to take a security interest over their business assets and potentially also ask for a personal guarantee. If a bank or other financier were providing a loan, they would expect security to ensure repayment and so should you.
A well-drafted loan agreement will give you grounds to demand repayment. However, it won’t give you a specific claim over any of your friend’s property making it harder to enforce your right to repayment. Enforcing your right to repayment can be especially difficult if the business goes into administration because without a registered security interest you will be considered an unsecured creditor (your friend may have many secured creditors who have priority over you). Consequently, your friend may not be able to settle their debt to you.
For a loan to your friend’s business, the best security would be over all of the business’ assets, or over specific assets such as equipment or land owned by the business. To give yourself the best protection you will need to register this interest. It is advisable to search for any prior security interests which are registered over these assets before you agree to lend the money and use these as security. To further guard your money you can also ask your friend to sign a personal guarantee. The personal guarantee means that you can seek repayment from your friend’s personal funds and assets if the business cannot or will not repay you, Hopefully, you won’t need to use the personal guarantee, but it will give you peace of mind.
If you are asked to lend money to a friend’s business, consider what doing so means for you. If you decide to push ahead with the loan, it is important to negotiate fair commercial terms for the loan. Consequently, you should see a financial benefit in return for your risk. To protect your interests, you should then have a lawyer draft a loan agreement setting out these terms. To ensure you receive repayment you should also take security over the business’ assets as well as a personal guarantee made by your friend.
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