The Bank of Mum and Dad has long been one of the UK’s largest mortgage lenders. But experience suggests it is also a major corporate lender. And that can be a risky position.
Many of the world’s great companies started with family money. Virgin Records owes its existence to a loan from Richard Branson aunt joyce. Mark Zuckerberg’s Facebook empire is said to have started with a $100,000 loan from his father. The list of loans of this type is long and may get longer.
According to the Center for Entrepreneurs, today’s young people launch twice as many businesses as the baby boom generation. Last year, a record 900,000 companies They started in the United Kingdom. These include 82,000 new online retailers and 21,000 new street food and takeaway stalls.
Unfortunately, many of them will fail. My friend David Molian at the Cranfield School of Management recently told me a story about a retired businessman (let’s call him Richard) who had gone on to run the US subsidiary of a well-known UK company.
A son from his first marriage liked his skills as an entrepreneur, and Richard backed his new e-commerce business with a £100,000 equity injection, giving him a significant minority stake. The startup started well, but after 18 months it failed and ran out of cash. Richard provided a further £150,000 in loans. His second wife was not happy at all. Richard’s son made some reckless decisions. Three years later the company was declared insolvent. Creditors and shareholders received nothing.
“[The father] He had spent his entire life as a careful steward of corporate assets. His son saw himself as a buccaneer who took risks. It took him a long time to heal the personal rupture caused by the business failure,” says Molian.
Wanting to help your children is natural: many parents want to help their children climb the real estate ladder; many will also have paid for private education.
However, investing in a child’s business can be a more difficult task. Thinking like a professional banker can be helpful.
If you are faced with such a request, ask to see a business plan. It will give you an idea of the magnitude of your child’s ambition and may even get you excited. Writing down your research on the proposition, market opportunity and costs can encourage you to think deeper about the challenges.
Research shows that if you are an entrepreneur your children are 60 percent more likely to be an entrepreneur. If you have business experience, you can give valuable advice at this early stage, assuming your children are ready to take it on – a big assumption, in my experience!
One of the biggest mistakes that the Bank of Mom and Dad makes is not being clear about the conditions of the financial agreement. Is this a gift or a loan? If it is a loan, how much is it? What are the payment terms? What is the interest rate? (Notice how they narrow their eyes when you ask them that.) And what happens in case of non-compliance? Will there be any assets to claim against if the business fails?
Draft a written agreement that establishes the conditions of the loan. If it is a large loan, don’t be afraid to hire an attorney. If the business fails, as many do, a formal legal agreement could help ensure that you are recognized as a creditor.
Research suggests that default rates on unmanaged loans among family and friends decrease significantly if there is a signed agreement with a monthly payment plan and automated electronic bank payments.
Your child may ask you to “invest,” as Richard did. As with any capital investment, you need to establish an expectation of return. How and when will you make profits? Will there be a dividend or growth in its share value? A written agreement is even more necessary in this scenario because others may co-invest later as the business grows (hopefully), diluting their initial equity stake. You need to have a clear idea of your position.
And while you may be just getting over the shock of the initial sum, consider how far you’re willing to go beyond that first investment. Business angels have a general rule: when an investment is made, the same amount is set aside again for contingencies. Overly optimistic company founders almost invariably come back for more money.
If your money is a gift, you might consider it part of your estate planning strategy. Many clients tell us that they have given a cash advance to a child and need to match the inheritance, often removing that figure from the will so that their other children do not feel mistreated.
There are other ways to help your child’s business besides giving him or her cash. The loan of a garage, for example, free accommodation or your time. I know a retired father who helped his son launch an electronic game: producing, packaging and publishing items, and crafting search algorithms to win the top spot on Amazon’s site.
And while it was hard work, it brought father and son closer together.
Be careful: it may be the other way around. You can become an unpaid worker. Time has value. As with any loan or financial gift, be clear about the terms and limits.
The most important thing is to make sure you can afford everything you give, whether it’s money or time. Remember, the more sacrificial this is for you, the greater the risk that you will feel upset if you feel unappreciated or wasted.
It can be exasperating if you fall short on luxuries to support your child’s project and then discover that you are spending money on what you consider non-essential. Likewise, it can be painful for your son or daughter if he feels that he is working too hard and every time he wants to relax and pamper himself you are frowning in the background.
Ultimately, no two families are the same and emotions can be intense. Being a branch manager at the Bank of Mom and Dad is not an easy job. A more formal approach can take some of the emotion out of the equation for some families. For others, it might increase it.
Yes, there is a risk in supporting the next generation of entrepreneurs through the difficult stages of starting and growing a company. But many companies do be successful, and nothing can make most parents more proud than to think that they have played a role in that success. Entrepreneurs always remember those who trusted them at the beginning of the journey.
Shirley Coe is Senior Private Banker at Weatherbys Private Bank