Making Loans to Children
From time to time we encounter families who are facing the awkward decision of whether or not to offer money, either in the form of a loan or a one-time gift, to one or more of their children. The circumstances surrounding the situations vary; a child may be out of work and may need to invest in further education or career training. Perhaps a son faces an unfortunate financial hardship due to divorce or a daughter suffers from poor cash flow due to investments gone sour.
Regardless of the circumstances, parents often feel the urge to help. Perhaps out of a combination of genuine parental care, success of the business and their ability to determine how money is allocated, parents commit to financially assisting one or more of their children. By helping, the parents risk creating a situation that they did not intend, one that may strain their relationship with their children as well as among siblings and can potentially harm the potential for next generation success as leaders and owners in the business. By considering some of the following recommendations, parents can avoid many unfortunate outcomes.
In deciding to make a loan to a child, parents are motivated by the desire to help. Some consider the loan to be a very natural and normal response as a loving and supporting parent. Perhaps the parent feels guilt for time directed toward the demands of building a business and growing a legacy and away from the emotional needs of the family. Perhaps the business owners recognize disparities between their children s financial success. This is, after all, their flesh and blood in a vulnerable and unfavorable financial position. This is their child who is enthusiastically agreeing to pay back the loan promptly and in full. But in their haste to assist, parents may have missed the opportunity to evaluate how to ensure the greatest likelihood of repayment and how to avoid their worst-case scenario.
If you have chosen to make a loan to one or more of your children, we recommend that you consider the following suggestions.
First, treat the transaction as serious and professional, with promissory notes, written terms of the loan (i.e. loan amount, interest, repayment schedule, provisions in the event of a late payment) and even attorney review. In this way you gain the advantage of reinforcing the obligations of the loan and the ramifications if it is not repaid.
Second, invite the child's participation in drafting the agreement. The child's involvement not only allows for a greater sense of ownership of the agreement, but also ensures his or her familiarity with the terms and provides the opportunity to discuss any concerns or what-ifs around the possible ramifications.
Obviously, the written agreement alone cannot guarantee that the loan will be repaid. Parents who are considering whether or not to make a loan to a child should acknowledge the possibility that it may never be paid back in full. In fact, we are all too familiar with great intentions to repay and commitments to paying on time fading to interrupted pay schedules, excuses and silence that strain the parent/child relationship and even compromise access to grandchildren.
We understand that in most cases parents don't want to nag, remind, confront or even elevate the situation legally to recover the loan balance. After all, they have a family business to run together, grandchildren to enjoy and leadership to transfer to their children with the greatest odds of success. Indeed, we recommend that parents who are deciding whether to make a loan to a child be prepared to forgive the balance should the agreement break down. In this sense, then, the parents should be cautious to make loans only up to the amount they are willing to forgive.
Here are several recommendations on how to forgive a loan properly:
First, if you are forgiving the loan, choosing to consider it a gift instead, recognize the parity concerns with your other children. The loan should be viewed as an advance on the debtor child s inheritance. That is, an amount equal to the forgiven balance should be taken off the top for each additional child before the estate is divided among all the siblings.
Second, if there was a promissory note, especially one with an interest amount, terminate (call) the note. In so doing, you are eliminating the possibility that in the unfortunate circumstance of your death, other siblings will not inherit the role of creditor to their other sibling.
Finally, as is important in many family business affairs with multiple generations involved, make open communication about your financial decisions a priority when those discussions have an impact on your children. By explaining what is happening (making or forgiving a loan), what terms are agreed upon, whom the transactions involves and the reasons behind your decisions, you are removing any potential doubt and greatly assisting the next generation to succeed as a cohesive and cooperative team.