Hitting Up A Pal

Choosing an interest rate; startup paperwork

Q: I am starting a business and plan to ask friends and family to help finance it. How can I choose an interest rate that is fair to them and manageable for me? — Angie Leszczak

A:

About half of all small business owners borrow from friends and family, and for good reason. Many new entrepreneurs can't get conventional financing, and loans from people you know are typically cheaper than either bank loans or credit cards. Rates on business credit cards run about 12%, and commercial and industrial bank loans averaged about 7.2% in 2006. But loans from family and friends carry an average rate of 6.7%, and those from business associates run about 8%, says Circle Lending, a Waltham (Mass.) company that specializes in structuring such loans.

In setting rates, the first thing to establish is your lenders' expectations for their money. Consider how they might otherwise use it, say, investing in a bank CD or stock, to give yourself a basis for comparison. If yours is a high-risk venture, make sure your potential lenders understand what they're getting into. They will expect to be paid more for taking more risk. Loans to biotech or high-tech companies, for example, might carry rates one to three points above the averages.

You can also do some research online to try to get an idea of the interest rates that other private borrowers and lenders are using. On Prosper.com, for example, people who want to borrow between $1,000 and $25,000 can seek lenders. After viewing information on potential borrowers and their businesses, lenders make bids, essentially offering a certain amount of money at a specific rate. In January, rates started around 7.5% on loans to the borrowers lenders deemed most creditworthy.

You'll also have to discuss the structure of the loan—how much you'll pay back, and when—as you hammer down a rate. Do you want to pay your lenders lump sums, referred to as balloon payments? Or do you prefer graduated payments—ones that start out small and get gradually larger? Seasonal businesses may want to make payments only during the busy months.

Friends and family tend to be flexible about repayment. "This is patient capital," says Asheesh Advani, president and founder of CircleLending, which administers loans between friends and family. Still, it's a good idea to put things in writing. That may prevent your uncle from exploding if you take a trip to the Caribbean before you've repaid him.

Q: I'm a full-time student and have just started a business. I'd like to buy merchandise wholesale and sell it online. I have had only a few sales so far. Do I need to get a tax ID before Apr. 15? What other paperwork and certifications do I need? — Sarah D'Ardenne

A:

The paperwork is pretty straight forward, says Samuel Katz, a New York-based CPA and chairman of the small firms practice management committee for the New York State Society of Certified Public Accountants. First off, you need to apply for a taxpayer ID or Employer Identification Number (EIN). You can do so online at www.irs.gov or by filing an SS-4 form. You also need to apply for a general resale certificate. You can get those forms from your state department of taxation. Because you had sales in 2006, and because tax id numbers can't be backdated, you should file your business income and expenses on a Schedule C with your personal return by Apr. 15.

Katz says you also need to decide whether to incorporate or run your business as a sole proprietor. If you choose to incorporate, it's a good idea to get help from an attorney or CPA. In either case, you need to record your business income and expenses and keep them separate from personal expenses. Sole proprietors include this information on their Schedule C, filed with their 1040 form, as you'll do this year. If you incorporate, you'll file this information separately with your new business' income tax forms.

If you have a question for Smart Answers, email us at smallbiz@businessweek.com and make sure to put the words "Smart Answers" in the subject line

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