When starting in business you want to use all the resources you can, and that includes family members if you have them and they’re ready and willing to help. Here are some ways in which you can leverage family to help you get started. But beware: there are drawbacks to consider. Your business may be of finite duration, but family is forever, and you want to be sure and preserve relationships above all else.
How family can help get you started:
Parents, grandparents, siblings, cousins, and other family members may be a great source of funding your business. They may be able to lend you money on favorable terms or invest in your business. Here are some points to keep in mind:
- Don’t borrow money from any relative if your inability to repayment them could have serious consequences for them. Only borrow if the relative is financially able to “lose” the money.
- Pay attention to loan formalities. If you borrow from a relative, be sure to have a promissory note with all required details (e.g., interest, repayment terms, consequences for nonpayment). If you don’t and the IRS views the situation, your relative may be treated as having made you a gift for which a gift tax return could have been required. What’s more, if you don’t repay, the promissory note and adherence to its terms may enable your relative to claim a bad debt deduction. Even if a relative wants to make an interest-free loan, consider setting enough interest to avoid the below market loan rules that could trigger phantom interest income to the lender.
- Don’t share ownership of your business without careful consideration. Once a relative gets an equity interest in your business for funds he or she contributes, it’s not easy to disentangle yourself if you want to later on. What’s more, depending on the extent of that equity interest, your relative may have a say in how you run your business, even if you don’t want to go it alone in the future.
You may have family members who can provide some technical advice and/or assistance to get you started. Perhaps there’s a lawyer or accountant related to you who can help. Maybe your cousin is a graphic designer who can create a website for your business.
Just because you have relatives who are professionals doesn’t mean they’re the best choice for assistance. They may not have expertise in areas you need. For example, if your cousin is a real estate attorney, she’s not the person you want giving you advice on the choice of entity for your business. And your relative may want the same payment from you as from any other client; you may not save any money working with a relative.
There are many pros and cons to putting your relatives on the payroll. Here are some to consider:
- You probably know what you’re getting when you hire a relative. Assuming the relative is capable, reliable, and trustworthy, you likely have a good employee.
- There are tax advantages in some situations. If you’re a sole proprietor, hiring your child, spouse, or other relative may avoid some payroll taxes. Whatever your type of entity, compensation to them is tax deductible to you as long as you can prove they received it for work performed (keep timesheets) and that the compensation is reasonable.
- You can work a relative, especially a child, into your succession plan. While that may seem a long way off when you’re just getting started, you may need a successor at any time, in case of disability or a desire to more onto the next business opportunity.
- Difficulty in maintaining a level playing field. Relatives may believe they’re entitled to receive greater compensation and/or benefits simply because of their relationship to you. Other employees won’t like the fact that they are receiving less compensation for doing the same work as your relatives, so avoid this problem.
- Terminating a relative can have dire family consequences. It’s hard to fire someone you see at holidays or perhaps on a regular basis.
- Company culture can be compromised. If a relative thinks he or she doesn’t have to abide by company rules, other employees may become disheartened.
Princess Diana said: “Family is the most important thing in the world.”
We all know that’s true, but should keep it in the forefront when deciding to work with family members.