The type of financing provided by close friends and relatives does not normally vary much from that provided by strangers. The help may be in the form of a gift, a loan, or an equity investment. The big differences are usually the availability of money in the first place and the interest rate or investment return. With friend- or relative-provided financing, however, the commercial model isn’t the only one. A common alternative is the loan-gift hybrid.
Here a relative or friend lends you money at either a low interest rate, or with no interest at all, telling you to pay it back when you can and to treat it as a gift if you can’t. Obviously, this type of help is invaluable if it’s available. It gives you time to get your business established with a minimum of pressure. If you’ve any doubt about your angels’ financial position, make sure they consult their banker, attorney, or financial advisor before advancing you the money.
Also, check with a tax advisor if you receive a substantial gift in one year from any individual, since there may be tax implications. Generally, property you receive as a gift, bequest, or inheritance is not included in your income. However, if property you receive this way later produces income such as interest, dividends, or rentals, that income is taxable to you.
For additional information, refer to IRS Publication 17, Your Federal Income Tax. You can find this publication online at the IRS website www.irs.gov. Finally, write down the terms of the loan or transaction and make sure everyone thoroughly understands them. After all, you want to feel like you can go to family reunions even if your business fails.