A guide for family loans

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The phone call was like so many I have received during my 24 years as a financial consultant, yet the results were quite surprising. The caller had been referred to me for strategic planning by one of my college mentors. I sent him the usual pre-meeting checklist, requesting financial statements and tax returns for the last three years, as well as production information for the coming year. The surprise came when those financial statements were returned.

This particular farm operation was deeply in debt and unable to meet the family living obligations and service the debt that had been created. I found nothing that would help turn the operation around - quite simply, it had failed.

Yet, buried in those financial statements was another tragedy. The retired parents of the farmer had loaned their life savings to the young couple, and an uncle had also made a significant loan to the operation. All of this money was lost. I soon realized the producer had come to me to help break the news to his wife and family.

Families often help their members - that has been a tradition since the dawn of time. However, loaning money and co-signing loans can be hazardous to a family operation, especially when made based on emotion and not on business principles.

Back in the late 1980s, my firm conducted research of the farm crisis and found that a lot of the operations that had failed were two-generation firms. The second generation was underfinanced, and when problems occurred, the first generated tried to help, with both generations eventually losing everything.

Not all loans within families create heartache and financial problems. Use the following tips to ensure that you succeed:

1. Caution. Be cautious in making loans to anyone, especially family members. While it's better to leave lending to the professionals, if you do loan money to family members, make all of your decisions based on fact and not emotion. Require cash-flow and financial statements, just as a lender would.

2. Document. Execute a note with a fair market interest rate. If you don't treat the loan as a true business transaction, you won't be able to deduct any losses on your tax returns.

3. Don't co-sign or guarantee a blanket loan. If asked to co-sign a loan, agree to guarantee only a specified amount of money. This ensures that you have some control over the situation and will be able to limit your losses. Set a date for the guarantee to expire, thus providing you an exit. Have any guarantee reviewed by your attorney before entering into an agreement. Make sure that you understand your obligations and risks.

4. Maintain control. If a lender wants you to co-sign a loan for a son or daughter, consider borrowing the money yourself and loaning it to the son or daughter to maintain control of the situation. In this scenario, you will know how well the children are performing by their ability to pay back the loan.

5. Loan or guarantee only what you can afford to lose. Too many families just say "yes" without considering that they could end up writing a check or losing money. If you enter into a transaction knowing that it could fail, you can make informed decisions.

I'm not saying parents should avoid helping their children. Rather, you need to be aware that some ventures fail in spite of good intentions. Make sure that you can afford the loss before entering into any financial transactions.

Darrell Dunteman, AAC, is an Accredited Agricultural Consultant and accountant with offices in Bushnell, Ill.



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