Funding is sometimes done through gifting but usually a loan is used. Few kids want parents as equity partners. Asking for a loan seems more palatable than asking for a hand out.
The reality is many are approaching their parents for a loan because they can’t get a loan at a decent rate, if at all, from a traditional lender. It is amazing to me how many families view this as unfairness in the system rather than a reflection of the risk.
I go over the elements of both a good business plan and a bad plan. The work involved in putting together a good one usually ends the matter for those less capable or less dedicated children. The presentation of a bad business plan highlights the risk for clients. They may still loan the money but they are more likely to charge a decent interest rate and limit the size of the loan.
In some cases, the business plan was pretty good. Some worked out some did not but everyone at least felt better about the whole endeavor.
I am pretty adamant about getting good loan documents in place. Part of my insistence is that for many kids, it highlights the seriousness of the transaction and the business. It also provides a good document to have should the business fail and my clients wish to deduct the loss.
The business-plan approach works pretty well for most situations. One in which it does not is when the child is up to no good. The business pitch is sometimes just the story to get money out of the parents.
Like many fraudsters or abusers, they will seek to put a wedge between the client and those looking after the client’s interests. They may try to erode your credibility or convince the parents a business plan is not necessary because they or some other partner “knows the business.” It is also likely that some urgent news will arise such that there “is no time for a business plan. We have to move now or we will miss our opportunity.” Such is the language of the ne’er do wells.
Sometimes the kid means well but they are themselves being pitched by a crook. We’ve seen a few shady franchise deals over the years with ready-made business plans.
It is natural for parents to want to help their kids. When these business startups work, it can be transformative but those cases are the minority.
Protecting a client’s interests when they are keen on funding a new business for a child can be challenging. It requires a balance between being supportive and providing the cold hard facts of life for small businesses. If owning a business were easy, fewer small businesses would fail.
Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by several publications, is a past president of FPA and is a popular speaker on all things related to retirement advice and the profession of financial planning. He practices in Melbourne, Fla. You can reach him at www.moisandfitzgerald.com.