Bankrate notes that according to Asheesh Advani, chief executive at Virgin Money, there are some $89 billion in loans made between friends and family each year in the US alone. A significant percentage of these loans are business related loans used to help a company launch or grow. Small businesses and startups should resist the urge to borrow on a handshake or be willing to risk losing the relationship. As we approach the holidays there are going to be a lot of awkward Christmas parties where entrepreneurs have to face their family after falling behind on payments or failing to repay a loan entirely.
There are many reasons why you should take borrowing from friends and family very seriously and make sure you get things in writing with a standard loan agreement from TrustLeaf or another reputable source. One way to show that you are serious, and to protect both parties, is to create a set of financial projections to share with your lender before you sign on the dotted line.
There are 3 key reasons why financial projections are important when borrowing from friends and family:
1. Can You Realistically Pay the Loan Back?
First, the process of creating a set of detailed financial projections will force you to take a realistic look at whether or not you will be able to pay back the loan, and in what time frame. Many entrepreneurs have optimistic ambitions of paying back the loan quickly, but the challenge is that most early stage companies need all of the cash they can get in order to grow, so an aggressive payback term is potentially very damaging to the business. The simple rule of thumb is that it is better to say it might take you 10 years to pay back the loan, and instead you pay it back in 5 rather than projecting a 5 year payback and stretching it out to 10.
2. How Much Room for Error is There?
Creating a set of financial projections also allows you to determine how much room for error there is with regard for your ability to pay back the loan. Do you have multiple sources of repayment? Or does everything rely on securing that one huge Wal-Mart contract? It is important for the lender to understand how much risk is involved with the loan. Maybe you have a day job and you could pay back the loan from your salary if the business didn’t take off as expected. Or maybe you have a personal savings account that you could tap into if you absolutely needed to. If your projections show that everything has to go exactly right for you to be able to pay off this loan, you must share this with your lender ahead of time so that they understand what they are signing up for.
3. An Accountability Plan
Finally, your financial projections can serve as an accountability plan. Without projections it is going to get really old each month when you have to email your lender and say that you can’t pay this month, or that you are going to be late this month. The lender is going to assume you are just ripping them off. If you had a clear plan with projections from the start, then you can clearly show where your projections differed from reality and easily explain why you can’t repay this month. This protects you and the lender from hard feelings.
So before you ask for that business loan this Christmas, create a set of projections first, and do it the right, professional way to preserve relationships and friendships.
You can get started with financial projections for free using the ProjectionHub app.
About the Author: Adam Hoeksema is the Co-Founder of ProjectionHub which is a web application that helps entrepreneurs create realistic financial projections for potential lenders and investors