If you’re borrowing money from friends, family, or others for your business, you may be wondering the best way to structure the loan so that you get the funds yet receive some protection in the process in case something goes wrong.
Although there’s no one-size-fits-all solution to this problem, here are two effective tactics.
1. Promissory Note.
Like other loans, a promissory note in exchange for the money is a standard method of stating the terms and conditions under which the loan will be repaid. This typically includes interest that accrues at a fixed or variable rate until the loan is paid in full (principal and interest). Of course, the terms of the note are negotiable.
And if you’re not dealing with a sophisticated lender, or the loan is being made as a personal favor, you may be able to structure the deal where your business entity (e.g., LLC) is the borrower instead of you as an individual and there may not be a requirement that you personally guarantee the note in the event that the business is unable to repay the loan.
2. Profit Participation Financing Agreement.
Although less common (except in the Islamic world) than an interest-bearing promissory note, a profit participation financing agreement is a viable alternative with some private lenders.
With a profit participation agreement, instead of receiving interest, the lender shares in a percentage (e.g., 50%) of any profits generated by your venture and typically bears the risk of loss of principal if things go bad (unless you commit some type of misconduct).
Of course, there are other loan options than these two methods. Yet you should consider these because of their simplicity and ease for borrowing needed funds for your business.
If you need help with a promissory note or profit participation agreement, it’s probably time to set up a phone consultation with Business Lawyer Mike Young.