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Lending money to support a friend’s new business can be challenging to navigate, both legally and personally. On the one hand, you want to see your friend’s business succeed and help ease any financial difficulties they encounter. On the other hand, there are several considerations to work through, even if you incline to trust your friend and their business. It is vital to do your due diligence and protect your financial interests before you lend money. You can do this through a well-written loan agreement, setting out the terms and details of the loan.

This article will set out:

  • key considerations about whether to lend money to a friend’s business;
  • how to conduct due diligence; and 
  • the importance of a tight loan agreement.

Considerations About Whether to Lend Money to a Friend

There are lots of elements to consider before lending money to a friend’s business. The financial considerations can often be at the forefront of your hesitation. After a discussion with your friend, you should be able to understand: 

  • why your friend and their business needs money;
  • how they will use the money; and 
  • the general expectation for repaying the money. It is best practice to spell these expectations in a loan agreement if you proceed with the loan. 

As far as possible, you should try to objectively assess the risk of lending money to the friend’s business. Likewise, be realistic about the chance that you lose your money, for instance, if the business defaults. You should not lend money that you need or more money than you feel comfortable parting with.

In addition to legal and financial considerations, there are personal factors to consider. Having a loan always affects a friendship, without exception. It adds an extra, often unwanted, edge to the loan dynamic. 

Moreover, there is an additional risk. If your friend’s business fails to pay back the loan, it may have a terrible impact on your friendship, and this consequence can be hard to avoid. Even if the business does repay the loan in the end, there can often be significant guilt and tension between friends for some time. Likewise, willingly giving a loan in the first instance does not spare you from tension later on. 

There are other consequences for lending to a friend. Your loan may not be a top priority for repayment from the business when prioritising its debts. It is common for loans from family or friends to be seen as a ‘friendly debt’. This means you may receive payment after other lenders.

Tip: Ensure you work these details out in the loan agreement.

Doing Your Due Diligence

Even though it may be a close friend asking for financial help, you need to assess the situation objectively. Always conduct comprehensive due diligence on your friend’s business and the reason they are asking for money. 

For instance, if they are approaching you for money, the bank may have already rejected their credit request. If a bank assesses that lending your friend’s business money is too risky, that is a red flag. Consequently, you should appreciate the risk that you may lose your money.

Another aspect of due diligence to conduct is to check the business’:

  • finances;
  • strategic documentation; and
  • future growth plans.

Try to understand the wider context of the business and fully appreciate the risks of a loan. It can be a good idea to get a lawyer to check these if you are considering a significant loan, particularly to get an outsider’s perspective. 

The Importance of a Loan Agreement

It is vital to set out your loan agreement in a formal legal document if you agree to lend money to your friend’s business. No matter how close you are to a friend, it is best practice to have a full legal agreement. This includes key commercial clauses setting out the details and terms of the loan. At the very least, the agreement should detail:

  • the amount of money you are lending; 
  • when your friend will repay the amount; 
  • the purpose and context of the loan;
  • any early repayment terms;
  • the interest on the loan;
  • a dispute resolution process; and 
  • the termination options.

Both you and your friend should have independent legal advice on the wording of this document before you agree to it. 

Key Takeaways

It can be a difficult decision to decide whether to lend money to a friend’s business. There are several considerations, particularly in terms of legal and financial perspectives. You should try to assess the prospective loan objectively, taking your friendship out of the equation as far as possible. This should involve due diligence of your friend’s business and an understanding of why they want the money and why they need to seek it from you. In any case, you should have a loan agreement setting out the terms and details of any loan you agree to, no matter if the borrower is a friend or not. If you want to know more about lending money or get assistance with drafting an agreement, contact LegalVision’s corporate lawyers on 0800 005 570 or complete the form on this page.

Frequently Asked Questions

What are the risks of lending money to a friend’s business?

There are both financial and personal risks when lending money to a friend’s business. Mainly, your friend’s business may end badly and default. Consequently, you lose your money.

There are also non-financial risks. For example, your relationship might suffer when it includes a new dynamic of borrowing and lending money. There is also a combination of financial and personal issues, such as when your friend’s business does not prioritise paying back your loan.

Why should you have a loan agreement if you are lending money to a friend’s business?

Lending money to a friend or a friend’s business is a significant commitment. It is important to document any interest you both have and protect the interests by recording the details of your agreement.

Is it usual to ask for commercial terms or a reasonable interest rate when lending money to a friend’s business?

Yes, it is common to receive commercial terms even if you lend money to a friend’s business. You are taking on some risk by lending money and so you have the right to receive some kind of financial benefit.

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