Lending money to your children or grandchildren for their business ventures might seem like a loving gesture, but it’s fraught with risks and potential tax complications. It’s a scenario that’s becoming increasingly common in the UK, where the traditional avenues of business financing are drying up, leading more entrepreneurs to turn to their families for support. In the Financial Times today, a Chartered Financial Planner warns of the perils of such arrangements.
The Hidden Dangers of Family Funding
The Surprising Statistics
Recent research from Charles Stanley highlights how intertwined family finances and business ventures are in the UK. In a survey of 500 business owners and entrepreneurs, 19% admitted to sourcing funds from their parents, while 10% relied on their grandparents or other family members. Furthermore, 15% used their inheritance for business growth, and 13% received additional funds from their parents.
The Risks to Business Owners
While getting funds from family might seem easier than traditional bank loans, it’s not without its complications. Informal loan agreements can lead to uncertainty. Questions like whether the loan can be recalled at any time or if interest might suddenly be demanded can cause significant disruptions to the business.
Moreover, if the money was a gift and the giver doesn’t survive for seven years after the gift, the recipient could be liable for inheritance tax. This tax burden falls on the business owner personally, even if the funds were invested in the business.
The Risks to Family Lenders
For parents or grandparents, the risks are manifold. They include the loss of capital, emotional pressure, and the potential for reduced or waived interest payments depending on the business’s performance. According to Experian, about one-third of new UK businesses fail within their first two years, underlining the riskiness of these investments.
The risks extend to the “four Ds”:
- Disagreement: What if a dispute over the loan damages family relationships?
- Debt: What happens if the business struggles or the owner declares bankruptcy? How will the loan be repaid?
- Divorce: In case of the business owner’s divorce, the loaned capital might be counted among assets to be divided.
- Death: The death of the business owner could significantly impact the business and the repayment of the loan.
The Opportunity Cost
There’s also the opportunity cost to consider. Money loaned for a business can’t be used for other family needs or goals, potentially leading to favoritism and family disputes.
A Better Approach to Family Financial Support
Given these complexities, he advises against funding a relative’s business. Instead, focus on personal legacies like helping children buy their first home or contributing to a junior ISA for new family members. With careful planning, this can be achieved in a tax-efficient manner.
Protecting Your Investment
For those who still choose to invest in a family member’s business, consider adopting strategies similar to those used by banks. For instance, “key person” insurance, which protects a bank’s investment in case of the business owner’s death or critical illness, could also be beneficial for family lenders.
While the desire to support your family is natural, the world of business funding is fraught with challenges that can strain even the strongest family bonds. When considering such a significant financial move, it’s crucial to weigh the risks and explore safer, more structured ways to support your loved ones financially.