Peer to peer lending (person to person lending) is an alternative loan source for family business entrepreneurs seeking funding.
According to leading family business expert
"With the current recession and when banks are refusing to make loans, family business entrepreneurs are seeking innovative financing solutions to grow their family business. Peer to peer lending can be an attractive option for a family businesses."
Schwerzler has been studying and advising family business entrepreneurs for more than 40 years and he is the founder of the
Family Business Institute.
and their web organization Family Business Experts.
According to Wikipedia, “The marketplace model of Person to Person Lending on the internet enables individual lenders to locate individual borrowers and vice-versa. This model connects borrowers with lenders through an auction-like process in which the lender willing to provide the lowest interest rate "wins" the borrower's loan. The marketplace process may include other intermediaries who package and resell the loans, but the loans are ultimately sold to individuals or pools of individuals.
The "family and friend" model forgoes the auction-like process entirely and concentrates on borrowers and lenders who already know one another, as with two (or more) friends or business colleagues formalizing a personal loan. Whereas the primary benefit of the marketplace model is the "match making" aspect, the family and friend model emphasizes online collaboration, loan formalization and servicing.”
In both the peer to peer lending model and the family and friend lending model, the key is the formalizing of the loan agreement. In peer to peer lending amongst family members, the loan agreement between family members can be as simple as a promissory note. A promissory note is simply a written promise to repay a loan or debt. The promissory note includes the names and the under specific terms - usually at a stated time, through a specified series of payments, or upon demand. To make sure the documentation is done correctly, consult your attorney or CPA.
The legal elements of a promissory note can vary from one state to another. A good place to find legal forms for promissory notes and many other types of legal documents is LegalZoom.com. For more information about the many types of legal forms they provide, click
Check out EASY LEGAL FORMS
Peer to peer lending strategies can be applied to parent-child loans - not a strategy just for the family business.
CNNMoney reports that in the US about $45 Billion of parent-child loans are extended every year. These loans are made to pay mortages, auto loans, student loans and credit card debt. About 14% of these intra-family loans end up in defualt.
Parent-child loans can be a huge problem for families in business together – especially when they are not documented or formalized. Very often the parent-child loans are kept a family secret – something not shared with other family members.
In one case, parents loaned $50,000 to one son to start a business. The business was still struggling to be successful – when both parents were killed in an auto crash. The loan to the son became known to the other three siblings. The wrangling about the undocumented loan ended up in the estate litigation and destroyed family relationships. The loan documentation strategies associated with peer to peer lending would have saved this family a great deal of heartbreak and legal fees.
Don Schwerzler, founder of the Family Business Institute and a family business consultant with more than 40 years of experience working with family business entrepreneurs, agrees that formalizing loans between family members is smart strategy, one that can avoid the many pitfalls associated with intra-family lending. “I can’t begin to tell all the horror stories associated with family loans. For many family businesses, the family business is the family bank. So when problems about family loans crop up, they not only impact the family business, but these family loans, especially those loans without proper documentation, can destroy family relationships”, says Schwerzler
Another reason to consider formalizing a loan between family members – if the family member fails to pay back the money, the money loaned to a family member can be deducted as a bad debt deduction.
Diana Crawford is an Atlanta-based CPA and the managing partner of Crawford, Merritt & Company, a CPA firm recognized for their work with family-owned businesses. When it comes to peer to peer lending between family members, Diana offers this advice:
“Money loaned to a family member can be deducted as a bad debt deduction if certain criteria are met. Documenting this loan is essential to its deductibility. First, the loan must be a valid and enforceable obligation to repay a fixed or determinable amount of money. The loan can not be construed as a gift, so a written agreement, signed by both parties is a must. The loan document needs to include the amount and the repayment terms. Second, you must have made attempts to collect the debt and have documented this process. Keep meticulous records on your collection attempts documenting phone calls, letters, attempts to locate debtor, declared bankruptcy, etc. Third, the basis in the amount loaned must be established. That is, the amount of cash loaned or the amount of court ordered payments that you have not received, but you have included in income, if required. Lastly, the debt is claimed as a short-term capital loss on Schedule D of the personal income tax return. The description should reference an attached schedule and the attached schedule needs to contain the business or family relationship with the debtor, the amount of the debt, the date of the debt, and the efforts you have taken to collect the debt. Each debt should be listed separately if you are deducting more than one debt.
The Alt v. Commissioner - Tax Court Case Docket No. 19964-04S - Filed June 27, 2006, illustrated that Section 166(d)(1) provides, with respect to a taxpayer other than a corporation, that, where a non-business bad debt becomes wholly worthless within the taxable year, the loss shall be considered a loss from the sale or exchange of a capital asset held for not more than one year.”
Family business entrepreneurs seeking alternative financing options should check out our pages on Factoring, Equipment Leasing and Alternative Business Financing.
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