Accounting Best Practices

Family Money
“It’s Just Business”
By Jennifer Parrilla
Published: September 2008

So, you have this fantastic idea for a business with all of the details worked out except for one; you need money to get the whole thing off the ground. But where do you go? At this point, your business isn’t more than an idea on paper and no bank will touch you with a ten foot pole. What about Uncle Monty? He’s pretty financially savvy and he may be interested in your business idea. Your buddy Bryan might want a piece of the action as well. Both may have a few extra bucks lying around, and better yet they might be interested in investing in you and your idea. But, before you crash the next BBQ with pleas for money, there are a few things to consider.

First, know your business plan and put it in writing. Because the devil is generally in the details, having your plan in writing shows that you have put a good amount of thought and effort into your potential business and that you’re committed to seeing it through. This will also help you to determine how much money you need and how it will be used. (Remember to be conservative in this estimate because, frankly, most people aren’t, and they oftentimes find out how painful it can be to have to go back to the well.) Also, be prepared to answer questions about your plan. You need to consider that any relative or friend of whom you are asking money is an investor, and any good investor will want to know how their money is going to be used. Having spent the time to thoroughly document your business plan will have required you to work through many of the questions a potential investor may ask.

So whom are you going to ask? Any money lent or invested carries risk and the investor should be made well aware of, and be willing and able to accept, those risks. Asking grandma to part with half of her retirement nest egg may not be wise, and certainly will not endear you to other family members in the event the investment goes south. You will also need to consider and be comfortable with the ramifications of different types of capital infusions (e.g. loans, common stock, preferred stock, etc). The scope of these considerations is a separate article in and of itself, but you should at least understand the basic fiduciary and other responsibilities you have to different types of investors, and whether you are comfortable having someone else involved in the decision making process.

Remember that no matter how clear you think you have been in discussing the potential investment, it is important to make sure the potential investor understands the deal by documenting all of the relevant terms, rights and conditions. The document doesn’t have to be special or fancy (although a legally binding document is best), but considerable thought should be used when drafting it, as misunderstandings can and often do happen. To minimize the possibility of such misunderstandings, spend some time up front documenting every detail you can think of with respect to the investment (i.e., at a minimum loan documents should include interest rates, repayment terms, security and covenants; whereas, equity investments should document ownership percentages, the type of equity instrument to be issued and any relevant rights associated with such instrument). This is the best way to safeguard the interests of you and your investor. Later down the line when your business is audited, the auditor will thank you too!

Each of the different investments, be they debt, equity or gift, carry various tax and financial reporting implications. For example, if the money is loaned to the business, all of the terms of the loan must be completely understood so proper financial disclosure and tax reporting can be made. Interest payments are tax deductible by the business, but interest income is taxable to the loan holder, and if the loan were to be forgiven it becomes taxable income to the business. A monetary gift to the business may or may not be taxable depending on whether it’s under the IRS annual exclusion limit for gifts. Those issues don’t even address what type of business structure may be right for you, and each type (e.g. C-Corp, S-Corp, LLC, LP) has its own financial and tax considerations. All of these issues are best addressed by an expert such as a CPA or attorney.

Family and friends can be powerful allies in both your business and personal lives, but don’t lose sight of the fact that there are reasons why it has been said that you should never do business with friends and family. Doing all the “right” things (i.e., being honest and upfront about everything associated with the investment, clearly documenting the terms as discussed above, etc.) can go a long way in avoiding potential problems, but be prepared to accept that money changes people and a bad investment recommendation could result in you damaging and/or losing a valued relationship. Conversely though, these types of investments, when successful, can make you a hero in your loved ones’ eyes. Just remember to continue nurturing the relationship that supported your dream with the same passion that you nurture your business, and you can weather the bad times and celebrate the victories together.

Jennifer Parrilla has been a member of the audit team at Kingery & Crouse since November 2000. A Tampa native and a USF graduate, Jennifer has served both SEC and privately held companies in the areas of real estate development, manufacturing, technology, and the medical industry. Kingery & Crouse, P.A. is a full service public accounting firm with a staff of 25 dedicated professionals providing tax and accounting services, including audits of SEC companies. You may contact Jennifer at (813) 874-1280 ext #236. Find them on the web at www.tampacpa.com.

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