Talk about a situation that's filled with danger. The wrong answer could cost
your friend and/or your money. Many of us will face the question during our
lives. According to the Federal Reserve Board there's 7 million loans worth $90
billion outstanding between family and friends.
So let's evaluate this loan on two levels: business and personal. Then we'll
take a quick look at some alternative solutions.
Any business can go bankrupt. Starting a new business is always risky. So there
is risk that Ray could lose his money even under the best of circumstances.
And, Joe's story sounds dangerous. If he was so successful in the past, he
shouldn't need to borrow money from friends. There should be 200 former business
associates he can try before approaching Ray.
Plus, the dot com bubble was not totally unexpected. Many good business people
avoided disaster by anticipating the danger. Investing a lifetime of savings in
a technology company just prior to the bust wasn't a particularly good move.
Not to mention that Ray can earn interest on his money without taking this much
risk. Joe really should be offering Ray some 'upside' if the new business is
successful. The best way to do that is to give him some stock in the company or
a stock option.
Ray should check Joe's credit score. How good has he been at repaying debts
since the bankruptcy? It would also be wise to ask a respected friend or two
what they think of the loan.
If Ray decides to lend the money, have an agreement drawn up and make sure that
everyone involved signs it. It should include repayment terms and what happens
if payments are late. Regular monthly payments are better than one lump sum at
the end of the loan.
It's not relevant in this case, but the IRS has rules about how much interest
you must charge when lending $10,000 or more to family members. You could be in
the awful position of paying taxes on interest income that you didn't receive on
a loan where you might lose the principal.
What about the personal level? Loaning money to a friend always changes a
relationship. Even a relatively small loan. And, typically the change is for the
A real friend generally won't put you in this bind. They value your friendship
more than a loan. They'll still like you even after you've turned them down. In
fact, someone who turns their back to you because you won't lend them money
probably isn't your friend.
If Ray makes a loan to Joe, he really needs to forget about the money. Just
assume that you will not get it back. Some people even suggest that a gift is
better than a loan. Inability to forget the money will always leave a barrier
between you and your friend.
Especially if Joe cannot repay the loan. At best he'll be embarrassed and avoid
Ray. At worst there will be a confrontation. In either case the friendship will
Perhaps the best solution is to find a way to help Joe without lending him
money. And, there are ways to help that don't require writing a check.
Ray could use his skills and contacts to help Joe get a loan from a traditional
lender. Perhaps help refine a business plan or introduce Joe to someone that you
know who invests in new businesses.
Offer to do a little research on the Small Business Administration's website <sba.gov>.
Not only do they make some loans, they guarantee many others.
Ray could also check to see if his state has a small business development
center. Even if they don't help financially, they have other useful services.
Bottom line? Lending money to friends is almost always a bad idea. If the loan
were safe, they could borrow from others. Just the fact that you're one of the
few options available means that it is unlikely that you'll ever be repaid. Ray
might lose a friend by refusing to lend Joe money, but it's better to lose a
not-so-close friend than to lose a real friend and your money, too, if a loan
can't be repaid.
Gary Foreman is a former financial planner who currently edits The Dollar
Stretcher website <www.TheDollarStretcher.com>
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