How should I document a family loan used to buy a business?

Family money is often part of a first acquisition, and it is the part most likely to be left to a handshake. Putting it on paper shows a lender the real structure of the deal and gives the tax rules something to apply to. BDC says it assesses the complete structure when it reviews a request, so a family loan belongs in the picture you hand your lender.

Decide what the money is

The first decision is whether the money is a loan, a gift or an investment, because the paperwork follows from the answer. One public program shows how evidence is read: when a third party pays for an asset, the CSBF program’s proof-of-payment rules ask for documents showing the borrower repaid that party, and say a confirmation only stating that the money is a gift is not acceptable. Records of what happened carry more weight than a label.

Terms worth writing down

The federal program requires its lender and borrower to sign a document setting out the principal amount, the rate of interest, the repayment terms, the frequency of payments and the day the first payment is due. That list is a sensible skeleton for a family loan too: the amount and date advanced, whether interest applies, the schedule, what counts as default, and where the family loan ranks if a bank or BDC is also lending. Your lender’s security rules will govern that last point, so ask it early.

Interest, security and tax

The Income Tax Act’s interest deduction refers to interest paid or payable under a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property, so a vague arrangement gives little to point to. The Act also has attribution rules, starting at section 74.1, for property lent to certain family members. Security is registered in the provincial personal property registry; British Columbia’s, for example, records security interests and liens against personal property. Your accountant should confirm the tax side.