By Matthew Helfrich
Aug. 21, 2018
A toxic combination of low entry-level salaries and high student loan debt is forcing many millennials to become more dependent on their parents for financial backing — and for much longer than previous generations. But if your adult child comes asking for financial support to start a business, is it finally time to say no? And if you do want to help, how should you do it?
Offering your son or daughter advice and encouragement to begin a venture is one thing, but financial involvement can put your hard-earned money at risk — not to mention add stress to the parent-child relationship.
The First Step
Here’s advice about various ways to assist your child in getting a business off the ground while prioritizing your own finances:
Before discussing giving your child money for a new business, first evaluate the business plan to see if it’s worthy of financial support. Are the business goals clearly defined? Is your child actually passionate about this idea?
It’s also important to qualify the intangibles of your child’s proposal. Has your son or daughter devoted a lot of thought and careful planning to concept development or do the efforts come across more lackadaisical?
If you’re convinced your child’s idea is solid, you’ll want to treat any financial transaction between you and your son or daughter as a serious business deal.
3 Questions to Ask Your Grown Child
There are three questions to ask your child: 1) How much do you need? 2) How are you going to use the money? 3) In what form do you need it?
This third question is perhaps the most important because it could have the greatest impact on your finances. Funding options include loans, investments and outright gifts; all have pros and cons and each should be evaluated carefully.
If you will be offering financial assistance, be sure your personal assets are protected before signing on the dotted line of any business agreement. You might recommend that your child establish the business as an LLC (limited liability company) in his or her own name to keep your personal finances out of the mix if the company can’t pay off business debts.
Now, onto the four ways of helping: making a loan, making an investment, making a gift and offering advice.
Making a Loan
Loaning money to a family member can be tricky, not only because of the family dynamics at play but also because of the potential financial and tax implications.
For instance, legally you must charge interest, according to Internal Revenue Service (IRS) rules — roughly between 2.5% and 3%, these days, depending on the length of the loan.
If your child can’t repay the loan, you can forgive the debt, but there are likely additional estate, gift and income tax considerations.
An additional upside to loaning — as opposed to giving — the money is that it lets you show you believe in the company without having to take an ownership stake. It also teaches your child responsibility and instills a sense of accountability.
It’s important to have a formal loan agreement drafted by an attorney who understands the dynamics and goals surrounding the business opportunity. The agreement must be signed by you and your child. This will prove the loan’s legitimacy in the eyes of the IRS and help establish repayment boundaries.
Making an Investment
Investing money in your child’s business may be a good strategy, especially if you’d like to play a deeper role in the business. Plus, when your son or daughter succeeds (fingers crossed), you succeed.
Be sure to document any investment in writing, with clear ownership terms and an operating agreement. It’s important that both the child and parent go through the various scenarios of buy-in, buy-out and voting decisions early on in the venture. If you and your child find it difficult to come to an agreement on an ownership stake vs. an investment amount, consider working with a third party to help mediate the differences.
Making a Gift
Perhaps you’d prefer to simply gift the money to your child. This is a particularly good option if you are concerned about the business putting a strain on your personal relationship. That said, it’s important to be sure you’re gifting the money in the most tax-efficient manner.
Based on current tax law parents can give a child up to $30,000 a year ($15,000 per parent) without owing a gift tax. (The amounts are $14,000 each or $28,000 from both parents in Canada.) Anything over that amount is subject to a gift tax rate of 40% — a hefty sum for any parent to endure. For an amount above $28,000 -30,000, you may be able to draw against your lifetime estate tax exemption or structure the gift in the form of a loan that could be forgiven over time. Such options should be discussed with your attorney, financial adviser, and tax professional.
Providing financial support isn’t the only way to demonstrate your belief in your child’s business. In fact, many times grown kids are simply looking for ongoing business counsel, because they value your experience and expertise.
If you don’t want to risk compromising your nest egg, consider offering advice instead of money. Your child may choose to write you into the business plan as an advisory member or, if the venture is successful, with a seat on the board of directors.
Whichever way you decide to go — if you do decide to assist your son or daughter— good luck to your child, the business and to you.