Beware the Bank of Mum and Dad’s grey areas

The Bank of Mum and Dad has long been one of the UK’s biggest mortgage lenders. But experience suggests it is a significant business lender too. And that can be a risky position to be in. 

Many of the world’s great businesses started with family money. Virgin Records owes its existence to a loan from Richard Branson’s Auntie Joyce. Mark Zuckerberg’s Facebook empire is said to have started with a $100,000 loan from his father. The list of such loans is long, and it may be getting longer.

According to the Centre for Entrepreneurs, today’s youth launch twice as many businesses as the baby boomer generation did. Last year, a record 900,000 companies were started in the UK. These included 82,000 new online retailers and 21,000 new takeaway and street food stalls. 

Sadly, many of these will fail. My friend David Molian at Cranfield School of Management told me a story recently about a retired businessman — let’s call him Richard — who had risen to head up the US subsidiary of a well-known UK firm. 

A son from his first marriage fancied his abilities as an entrepreneur, and Richard backed his new ecommerce venture with an injection of £100,000 in the form of equity, giving him a substantial minority shareholding. The start-up began well, but within 18 months faltered and ran low on cash. Richard pumped in a further £150,000 in loans. His second wife was less than happy. Richard’s son made some unwise decisions. Three years later the business was declared insolvent. Creditors and shareholders received nothing.

“[The father] had spent a lifetime as a careful steward of corporate assets. His son saw himself as a buccaneering risk-taker. It took a long time to heal the personal rupture caused by the business failure,” says Molian.

Wanting to give your kids a helping hand is only natural: lots of parents want to help their children on to the property ladder; many will have paid for private education, too.

Investing in a child’s business can be a tougher ask, though. Thinking like a professional banker can help. 

If you’re facing such a request, ask to see a business plan. It will give you a sense of the scale of your child’s ambition, and might even excite you. Writing up their research on the proposition, the market opportunity and the costings can encourage them to think through the challenges more thoroughly. 

Research shows that if you are an entrepreneur your children are 60 per cent more likely to be entrepreneurial. If you have business experience you can give valuable advice at this start-up stage — assuming your children are prepared to take it on board — a big assumption, in my experience!

One of the biggest mistakes the Bank of Mum and Dad makes is not to be clear about the terms of the financial arrangement. Is this a gift or a loan? If it is a loan, how much is it? What are the repayment terms? What is the interest rate? (Watch their eyes narrow when you ask them that.) And what happens in the event of a default? Will there be any assets to claim against if the business fails?

Draft a written agreement that sets out the loan conditions. If it’s a big loan, don’t be afraid to enlist a solicitor. Should the business fail, as many do, a formal legal agreement could help ensure you are recognised as a creditor. 

Research suggests that default rates for unmanaged loans between family and friends drop significantly if a signed agreement is in place with a monthly payment plan and automated electronic bank payments. 

Your child may ask you to “invest”, as Richard’s did. As with any equity investment there is a need to establish a return expectation. How and when will you realise a profit? Will there be a dividend or growth in the value of your share? A written agreement is even more necessary in this scenario because others may co-invest later as the business grows (hopefully), diluting your initial shareholding. You need a clear sense of your position. 

And, while you may only just be getting over the shock of the initial sum, consider how far you are willing to go beyond that first investment. Business angels have a rule of thumb: when you make an investment set aside the same amount again as contingency. Over-optimistic company founders almost invariably return for more money.

If your money is a gift you might consider it part of your inheritance planning strategy. Many clients tell us they have given a cash advance to one child and need to equalise the inheritance — often by carving that figure out of the will so that their other children do not feel hard done by.

There are other ways to help your child’s business venture besides handing over cash. The loan of a garage, for example, free accommodation, or your time. I know one retired father who helped his son launch an electronic game — producing, packing and posting items, and working out the search algorithms to earn top spot on the Amazon site.

And, while it was hard work, it brought the father and son closer together.   

Be warned: it can go the other way. You can become an unpaid labourer. Time has value. As with any financial loan or gift, be clear about the terms and limits. 

Most importantly, ensure you can afford whatever you give — be it money or time. Remember, the more sacrificial this is for you, the greater the risk of you feeling upset if you feel it is not appreciated or squandered.  

It can be infuriating if you are going short on luxuries to support your child’s venture and then discover them spending money on what you consider to be non-essentials. Similarly, it can be painful for your son or daughter if they feel they are working really hard and every time they want to relax and spoil themselves you are scowling in the background.

Ultimately, no two families are alike and emotions can run high. Being a branch manager of the Bank of Mum and Dad is not an easy job. A more formal approach may take some of the emotion out of the equation for some families. For others, it might heighten it. 

Yes, there is risk in supporting the next generation of entrepreneurs through the tough stages of business start-up and growth. But many businesses do succeed, and nothing can make most parents prouder than the thought that they have played a role in that success. Entrepreneurs always remember those who put trust in them at the journey’s start.  

Shirley Coe is a senior private banker with Weatherbys Private Bank

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