Dear Liz: My sister started a business two years ago. Needless to say, the economic conditions weren’t good, but at first she seemed to be doing okay. Lately business has dropped off dramatically and she’s asked us for a loan. We’re not sure if she was ever realistic or even truthful about her business’s prospects. What should we do?
Answer: In the history of business, there are many examples of companies that were saved from extinction by a loan from a friend or family member and that went on to great success. These stories get attention because they’re exceptions to the rule. Many, if not most, such loans never get repaid because the business couldn’t be saved and the proprietor refused to acknowledge reality.
If her business is viable, she may be able to get a loan from a local bank, although getting approved is still a challenge in these tight-credit times. If you are really her only hope, then you’ll have to decide whether you can afford to give her money you may never get back. If not, then you must decline. If so, you should write up a formal loan agreement, including interest rate, payment terms and penalties for non-payment, and have her sign it before you hand over the cash. Such an agreement may increase the chances of getting at least some money back, and can help you later if you need to take a bad-loan deduction on your income taxes.
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