Many would-be franchisees turn to family members for a loan when they’re raising money for a business – and this arrangement can have significant benefits on both sides.  

Borrowers will generally pay a lower interest rate and have fewer add-on costs, and it’s common for family members to have a more flexible approach to repayments than a bank. 

Lenders might earn relatively high interest even if they’re charging a lower rate than the banks. And there’s the satisfaction that comes from helping a family member to establish a successful career. But there’s also a potential downside. 

“If the borrowers are struggling to make the repayments, they could feel a lot of extra emotional pressure,” says Gess Rambaldi, a partner specialising in Business Recovery and Insolvency at Pitcher Partners.

“The lenders might think they have a right to be much more involved in the business than the borrowers would like. And, of course, there’s always the risk that the lenders will lose their money. All of this could put a lot of strain on the relationship.” 

When the family helps out

Families most commonly step in when there’s a shortfall between the money raised and the cost of the franchise.

“Depending on the business, most banks will only lend 40 to 50 percent of its purchase price,” says Akash Lodhia, managing director of Lodhia Lawyers and a solicitor specialising in commercial and property law.

“If you have borrowed as much as you can from the bank and there is still a shortfall, your only option might be to borrow from someone in the family.” 

At the other end of the scale, Lodhia has seen family members, usually parents, come up with the full amount. 

“If the banks have refused to lend any money, or will only lend a limited amount, I would strongly encourage them to investigate the business first because the banks will have had a good reason for their decision,” says Lodhia.

“For example, the proposed business may not be as valuable as it appears  because there’s a limited time left on the premises lease, old equipment need to be replaced or there’s been an application for a competing business close by. However trustworthy your relative, he or she may not be able to pay back the loan if the business is not sound.”  

There is also a spectrum of repayment options. “These range from ‘you pay me back when you can’ and ‘I won’t charge interest’ to an arrangement that is in line with one you would have with a bank,” Lodhia continues.

“Some family members go a step further by becoming shareholders, so they are not technically lending money but they have equal responsibility if the business should fail.”  

Rather than hand over cash, some family members put their assets at risk.

“A common example is where young adults want to go into their first business venture as a franchisee,” says Rambaldi.

“They’re unlikely to have the experience or personal wealth to give a bank sufficient comfort, so their parents might provide third party security to the bank, either in the form of a personal guarantee or a mortgage against their home.” 

You must document the agreement

Every loan, whatever its nature, should be well documented. “One of the most common problems we see in distressed businesses where money has been borrowed from the family is that the loan is not properly – or, sometimes, legally – documented,” says Rambaldi.

“A family member may have lent the acquisition cost of the business but, unless that is well documented and the loan is registered under the Personal Property Securities Act, the liquidator will not consider that family member to be a secured creditor,” adds Lodhia.  

Further protection is available, most commonly some form of security over either the assets of the business itself or over assets that are not part of the business, such as the borrower’s real estate. 

“If the business should become insolvent and unable to pay all of its creditors, a franchisor or bank will take priority over family members because they are likely to have security over the business assets,” says Rambaldi.

“Family members could also take security for a loan given to a business. This is still likely to rank behind that of a bank or franchisor but they will still have a better prospect of receiving some payment than ordinary unsecured creditors.” 

Family members can have very similar protection to a bank – for example, a personal guarantee will give them the power to enforce payments from the borrower personally and to seek judgement which could lead to bankruptcy proceedings. The question is would they be prepared to go that far?  

Some even find it difficult to ask for that level of protection in the first place. 

“I had a client who said he trusted his son but not his daughter-in-law,” says Lodhia. “He wanted the security of a mortgage on their property and also a personal guarantee, but he felt so uncomfortable about telling them that he asked me to recommend it. 

“From a lawyer’s perspective I would always recommend having some sort of security but, ultimately, it comes down to whether you really trust the person – not just their personal integrity but their ability to run a business.

“Both parties need to think very carefully about the worst case scenario where the money cannot be repaid. It’s not just money on the line, it’s the whole relationship.” 

Keeping business in the family 

Tom Spence has been a Battery World franchisee for 14 years and now owns two stores. When his son Mark decided to quit his job working underground in gold mines to spend more time with his family, Tom was more than happy to support the move.

He first employed Mark in one of his stores then helped him into a franchise of his own by covering the cost of the stock.  

“I had my own money but I still wouldn’t have been able to buy into a franchise without that help,” says Mark.  

Mark and his wife repaid the loan as agreed over the next two years. 

“They worked incredibly hard and we had a lot of meetings in that time to make sure that they were on the right track,” says Tom.

“They also gave me full disclosure, including access to their computers, so I could keep an eye on their margins. It worked well for me because I now have a son and daughter-in-law who are devoted to the business and I’m happy I was able to help shape their future in positive way.” 

Tom was confident he’d get his money back but still thought very carefully about all possible outcomes. “My first concern was our relationship,” he says. “Whatever happened, I didn’t want that to be at risk.” 

Take out the emotion 

Fear of losing the relationship could put pressure on a family to agree to a loan in the first place.

“In that situation, I think you’d want to take as much emotion out of the equat-ion as possible,” says Tom.

“The first thing I’d do is ask whoever wants to borrow the money to develop a bus-iness plan. That will give you an insight into their capability and the direction they want to take over the short to medium term. If you have any doubts, present them with the facts and focus on being rational.” 

Both Tom and Mark recommend including a spouse or partner in the negotiations. “You both need to be committed if the business is going to work,” says Mark.  

Any tension between a partner and the lender should also be taken into account. 

“A loan could deepen the rift, with the person who borrowed the money caught in the middle,” Mark continues. “These kinds of things not only threaten relationships, they would also make it a lot harder to run a business successfully.