Loaning Money to a Friend\'s Business
A friend asks for $50,000 to expand their business. They are good for it. The handshake feels enough. Eighteen months later the business slows down, the friend stops returning calls, and you find out the LLC has $400 in the bank and a stack of unsecured creditors ahead of you. The fix takes 30 minutes upfront: figure out who is borrowing, take security, and require a personal guarantee.
Who is actually borrowing
A loan signed only by the entity (LLC, corporation) is owed only by the entity. If the entity has no assets, you have no recovery. To get personal-asset access, your friend must sign:
- As an officer of the entity (binding the company), AND
- As a personal guarantor (binding their personal assets)
The signature line should look like:
BORROWER: Acme Coffee Shop LLC
By: Jordan Smith, Managing Member
GUARANTOR: Jordan Smith (individually)
The personal guarantee
A personal guarantee is a separate paragraph in the note (or a separate document) that says the individual is personally liable if the business defaults. Standard form:
"For value received, the undersigned [Name] personally and unconditionally guarantees the payment and performance of all obligations of the Borrower under this Note. Lender may proceed against Guarantor without first proceeding against Borrower or any collateral. This guarantee is continuing and irrevocable until the Note is paid in full."
Without this language, you have to chase the entity first, exhaust its assets, and only then go after the individual (a slow and often losing process).
Security: UCC-1 on business assets
Take a security interest in the business\'s assets. Steps:
- Identify the collateral (inventory, equipment, accounts receivable, intellectual property)
- Sign a security agreement listing the collateral
- File a UCC-1 financing statement with the secretary of state where the business is registered
- For specific assets (titled vehicles, real estate), additional steps apply (lien on title, deed of trust)
The UCC-1 makes you a secured creditor. If the business goes bankrupt, secured creditors get paid before unsecured ones.
Interest rate
Business loans between non-bank parties typically charge:
- 5-10 percent for low-risk friend loans
- 10-18 percent for higher-risk early-stage businesses
- State usury caps usually higher for business loans than personal loans, but check
The rate should reflect the actual risk. Charging 0 percent on a 7-year loan to a startup is a gift to the IRS\'s imputed-interest rules.
Repayment structure
- Interest-only with balloon: monthly interest, principal due at maturity. Common for short-term business loans (1-3 years).
- Amortizing: equal monthly payments of principal and interest. Common for longer terms (3-7 years).
- Revenue-share: business pays a percentage of revenue until balance is repaid. Higher risk for the lender, depends on revenue arriving.
- Hybrid: minimum monthly payment plus a revenue percentage. Combines stability with upside.
What to put in the note
- Principal and disbursement (one-time vs draws)
- Interest rate and how it accrues (simple, monthly compounded)
- Payment schedule
- Maturity date
- Late fees and default interest rate
- Acceleration on default, bankruptcy, or change of control
- Personal guarantee
- Security interest reference (UCC-1, etc.)
- Right of inspection (right to see books on request)
- Attorney\'s fees on collection
- Governing state law
Right of inspection
A right-to-inspect clause lets you ask for the business\'s financials periodically. Useful because:
- You see trouble coming before default
- The borrower has accountability beyond just paying
- If you ever sue, you have a paper trail of warnings
Typical: quarterly P&L and balance sheet, annual tax return, on request not more than once per quarter.
Equity vs debt
If your friend cannot make a serious commitment to repaying within a defined period, you are not making a loan - you are buying equity. That is fine, but:
- Document it as equity (LLC operating agreement amendment, corporate stock issuance)
- Understand securities-law exemptions (you typically need to be an accredited investor or qualify for a private-placement exemption)
- Accept that you might not see the money again
Mixing the two ("loan with maybe-equity-someday") creates a mess. Pick one.
Tax considerations
- Interest you receive is taxable income
- If the business defaults, you may have a bad-debt deduction (short-term capital loss for non-business bad debts)
- Forgiving the loan creates cancellation-of-debt income for the borrower
- Below-AFR rates trigger imputed interest under IRS rules
For loans over $10,000, talk to a CPA before signing.
If things go bad
- Send a default notice per the note
- Talk to the friend before suing - many situations resolve with a payment plan or extension
- If the entity has assets, foreclose on the UCC collateral
- Pursue the personal guarantor for any deficiency
- Sue for judgment and proceed to enforcement (bank levy, wage garnishment, lien on real estate)
Protecting the friendship
The single biggest predictor of friend-loan disasters is informality. Both sides assume the other will "just understand." A written note with clear terms, regular updates, and a personal guarantee usually saves the friendship even if the loan goes sideways. Without paper, you have a misunderstanding instead of a disagreement.