How to Build the Family Venture Capital and Loan Fund

Most people want to help their children and grandchildren, but they want to provide more than money. One goal is to ensure the future generations are hard-working and productive citizens who have initiative. Another goal is to perpetuate the family’s values. One of the values in some families is entrepreneurship. By encouraging entrepreneurial activities in the younger generations a family not only perpetuates this value but also helps fund the dreams of the young ones.

The good news is that most of these goals can be achieved with relatively small amounts of money. A family can start its own venture capital program to encourage the aspirations and fund the dreams of its younger members. It also is relatively easy to do.

There are several ways a family can establish its venture capital fund or bank.

One method is to set up a trust or other account that simply makes grants to family members who want to start or buy a business. With grants, there is no expectation of repayment and the family has no equity in the businesses funded.

Another method is to use the trust or account to make loans to family members.

Grants make it easier for the business to be profitable, because there are no loan payments or payouts to investors to reduce cash flow. An argument in favor of loans is that the borrower will not treat them lightly. There is a feeling of obligation to repay the family, and that could increase the focus on making the business a success.

Another attractive feature of family loans is that they can be flexible. Initial payments can be deferred for two or three years to make it easier to get the business established. If cash flow still is tight, the loan can be renegotiated or the family trust can provide cash to make the payments. On the other hand, if the borrower’s performance is unsatisfactory, the loan can be used as leverage to either increase focus or move on to something more suitable.

When loans are made, it is important to charge the minimum interest rate established by the IRS. There also should be paperwork documenting that it is a loan with repayment expected.

A loan also can have a convertibility feature. If the business is successful, the family trust at its option can convert the loan into equity. This allows the family to join in the profit from taking the risk.

Another approach to funding the program is to establish a line of credit at an independent lender. The family trust or family members guarantee the line of credit. An advantage is that the line of credit allows the family member to establish a separate credit rating. It also might ensure a greater sense of responsibility in the borrower, since payments are due to a third party and payment will be sought from the guarantors if the borrower falls behind.

Whichever approach is used, it should be clear that the money is available to all family members or all members of a generation. The family might want to establish standards for someone to qualify for the program. The standards should be fairly minimal, compared to what would be required by independent investors. For example, there might be requirements of a minimum age, a college degree, and no substance abuse problems. Some families require the prospective business owner to have held a job outside a family business for a couple of years. Thought should be given to the maximum amount of funding and whether the young entrepreneur should contribute capital.

The difficult issue in many families, especially those headed by a successful entrepreneur, is what additional qualifications to impose. There is a tendency to treat the family venture capital fund as a business and require the applicant to “sell” the idea to the family or a group of the family.

That process, however, might defeat the purpose. The idea is to help younger members of the family to pursue their dreams and find their own ways in life. Another goal is to establish and perpetuate family values of entrepreneurship and productivity. The more the older generations try to retain control, the more they stifle the desires and ambitions of the younger generations.

While the family venture capital fund might earn a profit, that is not the goal. The family members who contribute to the fund should use only funds they do not expect to have returned. The goal is to help the younger generations pursue their dreams, aspirations, and desires. Ideally, the businesses will be successful, because it would be ideal for the younger generation to learn that they can be self-sufficient and productive instead of indefinitely depending on the family wealth.