Parents would love to give their kids every opportunity in the world, but when your adult children come to you asking for financial support in starting a business, is it really a good idea? Offering your children advice and encouragement while they begin a new venture is one thing, but financial involvement can put a parent’s hard-earned money at risk — not to mention add stress to the parent-child relationship.
According to the 2016 “BNP Paribas Global Entrepreneurs Report,” Millennials are launching more businesses and have greater profit ambitions than their Baby Boomer counterparts had. And as younger generations continue to shift outside the typical 9-to-5 work life, parents must be prepared to guide them appropriately.
Here are a few questions that need to be answered before a parent should dive in.
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Who is going into business with whom?
The first step is to decide if you are simply providing seed money or if you are going into business with them. In our experience, some parents can mistakenly view a request for financial backing as a partnership invitation. So, it’s imperative to have a formal discussion about both parties’ goals and objectives early on. Make sure you come away from that discussion with a clear understanding of your child’s intentions to avoid a potentially uncomfortable conversation down the line. Additionally, accountabilities and goals need to be established and followed with clear and candid communication.
What type of funding will be required and in what form?
This is perhaps the most important question because it has the greatest impact on a parent’s finances. Are your children looking for a loan or an equity owner? Each of these has its own positives and negatives and should be evaluated carefully.
If you’re putting up money as a loan…
Lending money between family members can be tricky, not only because of the family dynamics at play, but also because of the potential financial and tax implications. For instance, if it’s a loan, then legally you must charge interest as dictated by the IRS. Moreover, if your children cannot repay the loan (because the business failed or is not performing as they’d hoped) you can forgive the debt, but there are likely other estate, gift and income tax considerations.
An additional upside to lending as opposed to giving the money is that it allows a parent to show they believe in the company without having to take an ownership stake. It also teaches the children responsibility and instills a sense of accountability.
Regardless of the circumstances, it’s important to have a formal loan agreement that’s been drafted by an attorney who understands the dynamics and goals surrounding the business opportunity. The agreement needs to be signed by you and your child. This will prove the loan’s legitimacy in the eyes of the IRS and will help protect you in the event of a loss. A loan agreement will also help establish boundaries for loan repayment and associated interest rates.
If you’re investing money as an equity partner…
Investing money may also be a good strategy, especially if you’d like to play a deeper role in the business. Plus, when they succeed, you succeed, further incentivizing all parties involved.
Even if you will be a “silent” partner, be sure to document the investment in writing with clear ownership terms and an operating agreement. Operating agreements can be tedious, but it’s important both child and parent go through all the various scenarios of buy-in, buy-out, voting decisions, etc. early on in the venture. If you and your child are finding it difficult to come to an agreement on ownership stake vs. investment amount, consider working with a third party to help mediate the differences.
If you’re just going to gift the money…
Perhaps you’d prefer to simply gift the money to your child. This is a particularly good option if you are concerned about the business putting a strain on your personal relationship. That said, it’s important to be sure you’re gifting the money in the most tax-efficient manner. Based on current tax law, parents can give a child up to $30,000 a year ($15,000 per parent) without paying gift taxes on the money. Anything over that amount is subject to a gift tax rate of up to 40% — a hefty sum for any parent to endure. For an amount above $30,000, you may be able to draw against your lifetime exemption or structure the gift in the form of a loan that could be forgiven over time. All of these options should be discussed with your attorney, financial adviser and tax professional.
Have you acquired the proper insurances?
This is a big one. Above all, parents must make sure their personal assets are protected before signing the dotted line of any business agreement. You might recommend that your children establish the business as an LLC in their own name to keep your personal finances out of the mix if company leaders are unable to pay off business debts. You should also make sure your children have procured the appropriate business insurances for their company.
What are our ongoing responsibilities to the business?
After financial terms have been finalized, it’s time to decide how you will be supporting your child in the business moving forward. Though in some cases this will be determined within the financial deal, ongoing responsibilities are not always clear to both parent and child. For instance, perhaps you decided to gift the funding to your children rather than invest in the business because you did not want to be considered an active partner, but your children were under the impression you’d be providing ongoing business counsel to them. It’s much more difficult to have that discussion after the fact than to put all your cards on the table upfront.
Final thoughts
One of the biggest mistakes I see parents make when looking to support their child’s business is that they don’t treat the transaction as a serious business deal. They find it difficult to have conversations about repayment plans or ownership agreements, so they avoid drafting up the proper paperwork to protect their own interests.
My advice to parents is to remember that — at this point — your children are not children anymore. They are adults, with their own goals and vision for the future. If you have the means and the desire to support those goals, make sure you’re not also interfering with your own. And remember, you have the right to say no if you feel the plan hasn’t been adequately developed or if you simply feel that the concept won’t work. The funding in question is part of your family’s legacy, so the proposition must be evaluated seriously.
Take the time to have an open and honest discussion with your children about your involvement and work collaboratively with them to determine the best financing options for all.
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