The Bank of Mum and Dad has long been one of the UK’s biggest mortgage lenders. But experience suggests it is also an important business lender. And that can be a dangerous position.
Many of the world’s great businesses were started with family money. Virgin Records owes its existence to a loan from Richard Branson’s Aunt Joyce. Mark Zuckerberg’s Facebook empire is said to have started with a $100,000 loan from his father. The list of such loans is long and can become longer.
According to the Center for Entrepreneurs, today’s young people start twice as many businesses as the “baby boomer” generation. Last year, a record 900,000 companies were set up in the UK. These included 82,000 new online vendors and 21,000 new street food stalls.
Sadly, many of them will fail. My friend David Molian at the Cranfield School of Management told me a story recently about a retired businessman—let’s call him Richard—who had risen to head the US branch of a well-known UK firm.
A son from his first marriage fancied his entrepreneurial skills and Richard backed his fledgling e-commerce venture with an injection of £100,000 in equity, giving him a significant minority stake. The startup started well, but within 18 months it failed and ran out of money. Richard took out another £150,000 in loans. His second wife was less than happy. Richard’s son made some wrong decisions. Three years later the business was declared bankrupt. Creditors and shareholders got nothing.
“[The father] had spent a lifetime as a careful custodian of corporate assets. His son saw himself as a fierce risk taker. It took a long time to heal the personal rupture caused by the business failure,” says Molian.
The desire to give your children a helping hand is perfectly natural: many parents want to help their children up the property ladder; many will have also paid for private education.
However, investing in a child’s business can be a more difficult question. Thinking like a professional banker can help.
If you are facing such a request, ask to see a business plan. This will give you a sense of your child’s level of ambition and may even get you excited. Writing out their research on the proposition, market opportunities and costs can encourage them to think about the challenges more fully.
Research shows that if you are an entrepreneur, your children are 60 percent more likely to be entrepreneurs. If you have business experience, you can provide valuable advice at this initial stage – assuming your children are prepared to take it on board – a big assumption, in my experience!
One of the biggest mistakes the Bank of Mum and Dad makes is not being clear about the terms of the finance agreement. Is this a gift or a loan? If it is a loan, how much is it? What are the repayment terms? What is the interest rate? (Watch their eyes narrow when you ask them this.) And what happens in the event of failure? Will there be any assets to claim if the business fails?
Draft a written agreement that sets out the terms of the loan. If it’s a large loan, don’t be afraid to ask a lawyer. If the business fails, as many do, a formal legal agreement can help you be recognized as a creditor.
Research suggests that default rates for unmanaged loans between family and friends drop 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’s did. As with any capital investment, there is a need to create an expectation of return. How and when will you make a profit? Will there be a dividend or increase in the value of your stock? A written agreement is even more necessary in this scenario because others may co-invest later as the business grows (hopefully), diluting your initial stake. You need a clear understanding of your position.
And while you may just be getting over the initial shock, consider how far you’re willing to go beyond the initial investment. Business angels have a great rule: when you make an investment, set aside the same amount again as a contingency. Overly optimistic company founders almost invariably come back for more money.
If your money is a gift, you can 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 carving that figure out of the will so other children don’t feel shortchanged.
There are other ways to help your child’s business venture besides handing over cash. Loan of a garage, for example, free accommodation, or your time. I know a retired father who helped his son start an electronic game – producing, packaging and posting items and working on the search algorithms to earn the top spot on Amazon’s site.
And while it was hard work, it brought father and son closer.
Warning: it can go the other way. You can become an unpaid worker. Time has value. As with any financial loan or gift, be clear about the terms and limits.
Most importantly, make sure you can afford whatever you’re giving – whether it’s money or time. Remember, the more sacrificial this is for you, the greater the risk of feeling resentful if you feel unappreciated or wasted.
It can be infuriating if you haven’t had the luxury of supporting your child’s entrepreneurship and then find that they spend money on what you consider non-essentials. Similarly, it can be painful for your son or daughter if they feel like they’re working really hard and every time they want to relax and pamper themselves, you’re drowning in the background.
After all, no two families are the same and emotions can run high. Being a branch manager of the Bank of Mum 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 can increase it.
Yes, there is risk in supporting the next generation of entrepreneurs through the difficult stages of business start-up and growth. But many businesses I DO succeed, and nothing can make most parents prouder than the thought that they played a part in that success. Entrepreneurs always remember those who believed in them at the beginning of the journey.
Shirley Coe is a senior private banker with Weatherbys Private Bank
