We’re speaking with Asheesh Advani, one of the founders of CircleLending.com, and the author of “Investors in Your Backyard: How to Raise Business Capital from the People You Know.”
NOLO: Asheesh, perhaps you can start out by explaining what CircleLending is, and what it does.
ASHEESH ADVANI: CircleLending was founded five years ago. We formalize and facilitate loans between family, friends, and business associates. The normal way people do these loans independently of CircleLending is, “Here’s $25,000 for your business; pay me back in five years.” And five years later, even if the business has gone very well, and the family is still living in the home, it’s very difficult to make a lump sum payment of $25,000 dollars; it actually takes a lot of financial discipline to save that kind of money. So, the default rate on these loans is very high. What happens after five years is, the borrower thinks, “Okay, now I’m going to have to start thinking about repaying the loan,” and the lender thinks, “This is when I start getting the full $25,000 back.” And that wasn’t ever communicated clearly at the onset. So, one person hears one thing, and one person says another thing. So the original insight behind CircleLending was to create repayment plans to make these loans work. Because when you look at the default rate on loans administered through a third party plan through a repayment plan, the default rate is much lower. If you want the numbers, the default rate on loans between family and friends that don’t involve CircleLending is around 14%, and the default rate on loans involving CircleLending is under 5%. Actually, for mortgages, it’s under 1%. So, people don’t tend to default on home loans. They tend to default a little bit more often on business loans, and on emergency personal loans.
NOLO: Why do you think the CircleLending default rate is so much lower than bank loans?
ASHEESH ADVANI: Well, I think we administer all the payments using direct debit and direct deposit, and I think that if the money’s in the bank account, we take it, which kind of forces financial discipline on you, and if the payments are late, or if you default, then it can impact your credit rating as well, which tends to really trigger certain types of behavior.
NOLO: Asheesh, let’s talk about your book. It’s a great idea, and an interesting book. But let’s just imagine that you’re a small business owner starting out, and you need maybe ten or fifteen thousand dollars, but you don’t really have any idea on how to focus on getting that money. What are the kinds of questions that you should be asking?
ASHEESH ADVANI: There are two things you need to think about. One is, who’s going to be able to supply the money, and the second is what form it should come in, and I think those questions are very related. There are certain types of people who will only invest money in the form of a loan, not as a gift or equity, and there are certain types of people who would much prefer to invest it as a gift or equity versus a loan. And, be clear about those two questions, as, you know, the first thing to think about that will help frame the conversation.
NOLO: In your book, you talk about the five C’s of lending. Practically, I wonder, when you go into a bank, is the person behind the desk really thinking of these five C’s, and which of the C’s are they focusing on?
ASHEESH ADVANI: That’s an excellent question, and it really gets at the heart of why people borrow money from family and friends. Banks used to make decisions based on the five C’s; that was what the vast majority of banks, say, twenty years ago, would look at. And they looked at all the C’s, but collateral was probably the most important one. Character, capacity, conditions of the business, and your credit history are the other ones. Now what’s happened is that there’s really only one C of credit, and that’s your credit history. Everything else is much less important than the credit score that you bring to the table in your bank application. And that’s true for a couple of reasons. One reason is, banks merged. And when banks merge, they tend to automate. A second reason is the power of your credit score as a predictor of the success of loan has really increased. So as credit reporting agencies have collected data on individuals, they’ve become very, very good at having a high degree of predictability. So banks now have a need to automate, and they’ve got this tool by which they can automate decisions. So now most decisions are made very quickly on small business loans, based on your credit score.
NOLO: So there’s a software component to it now.
ASHEESH ADVANI: Oh, absolutely, it’s completely automated, so that’s why you can apply for business loans online now. So, in fact, if you notice, when you apply for a business credit card, they don’t even ask you what kind of business you have. They don’t ask you the name of the business, they don’t ask you how long you’ve been in business, they don’t ask you your experience with it… they have no interest in your character, because it’s all reflected in your credit score, or so they believe. So, what’s happened in America is, you could have a great business idea and be an honest person with god character, but if for whatever reason you’ve got mediocre credit, you will not be able to get business financing through banks.
NOLO: Does a person who’s taking a loan from a bank always have to sign a personal guarantee?
ASHEESH ADVANI: Banks will definitely ask you for a personal guarantee, for all small business loans. That’s par for the course. Only at the highest end of commercial debt would you ever not involve a personal guarantee. For loans within family and friends, it’s totally optional. It really depends on your relationship, and what your lender is willing to bear in terms of risk. And there are some advantages to a personal guarantee; it tends to make the relationship actually more stable, because then the person feels you’re not hiding income or assets.
NOLO: Is there a particular business form that’s ideal if you’re seeking funding?
ASHEESH ADVANI: The question of which business form to use is a very broad question. Financing is one of ten factors you need to think about. I’ll give you one rule of thumb: if you are raising money for the kind of business that you think will incur a lot of losses in the early years, there’s an advantage to forming it as an S corporation. If you choose to do that, then there are financing implications as well, of the kinds of investors you should get, who may or may not want to pass that through to their personal income as a loss.
NOLO: Often you read that a person starting up a business needs a business plan, but then you also hear that investors or people who want to loan money really don’t want a business plan, they just want to know how likely it is that you’re going to make money, and when that will happen. Is a business plan really important?
ASHEESH ADVANI: A business plan is important for all entrepreneurs who are starting a business. But, if you are raising money from relatives, friends, and business associates, I would in fact not recommend bringing the business plan to the meeting. What they really want to know is, “Will you pay me back?” and “Can I trust you as an individual to find a way to pay me back?” And the way to address that is by looking them in the eye and being really honest and saying, “Here’s what my business’s chances of success are, and here’s what I’m going to do, even if it fails, to pay you back.” Having said that, if you don’t have a business plan to bring to the meeting, you should bring something else. And I recommend in the book that you should bring something tangible to show that brings the business to life: a brochure, a sample product, some piece of press about your or your business, something that helps people go, “Ah, that’s what I’m investing in.”
NOLO: When you’re borrowing from family and friends, there’s an emotional issue, especially if there’s a danger that you’re not going to pay back the loan. How do you deal with the emotional side of borrowing from people that you know?
ASHEESH ADVANI: Yes, I think it’s a very real concern when you’re borrowing money from friends and relatives. One, it could jeopardize the relationship, but it could also be a financial problem if you can’t pay back the loan for your lender or your investor. And both of those, I think, should be factored in, in terms of deciding who to borrow money from. So, don’t go to a person, like a grandmother, who’s on fixed income, to borrow money – bad idea. But having said that, at CircleLending, we’ve seen thousands of people borrow money from friends and relatives, and typically what happens when there’s a default is, the lender understands. The lender says, “Jeez, if I hadn’t created a repayment plan, then I wouldn’t have even got the first half of the loan paid back. So, I’m thrilled I got the first half paid back. Now, I understand this person’s going through difficult times.” Two things to think about: one is, the lender can deduct the loss against their capital gains, if they formalize the loan and show they tried to pay. So, that’s one element or value you can derive just by virtual formalizing. And the second thing to think about is you can restructure the loan so that it works for both parties. It doesn’t have to follow the payment schedule you outlined on day one; you can say, “Okay, I’m only going to pay you back fifty bucks a month for the next twenty months until I’m back on my feet.” So at least after twenty months, you’ve paid back a thousand dollars!
NOLO: It’s true that we can do a lot of this borrowing without lawyers. But are there times that a person needs to bring in an attorney?
ASHEESH ADVANI: Yeah, particularly if you’re raising money in the form of equity, I would consider a lawyer to help create the documentation for that. But for loans, I would say the vast majority of documentation is found either at CircleLending or in the book.
NOLO: Asheesh, thanks so much for talking to us today.
ASHEESH ADVANI: Thank you!
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