Occasionally, employees come to their employers strapped for cash and asking for a loan.
Lending money to employees may seem harmless, but if not handled correctly, the practice can cause significant problems and disruptions to an organization’s operations. Here are a few general comments regarding lending to employees:
Chronic Financial Problems
Employees who borrow from their employers generally have chronic personal financial problems. Unfortunately the problem is usually much more severe than the employee will let on, and the employee has come to the employer as a last resort.
It generally won’t be a one-time event. You want to be kind as an employer, but once this door is opened it is very difficult to shut.
Do some research to ensure the employee has not already attempted or committed fraud against the company. The “Fraud Triangle” identifies the 3 elements generally present if fraud occurs — Opportunity, Financial Pressure, and Rationalization. If an employee has come to you for a loan, they are most likely feeling financial pressure. Because of the many and shared responsibilities in a small business, many employees have the opportunity to commit fraud. And, a person under financial pressure and who may be overworked in a small business, can always find good rationalizations for taking “just what’s owed to them” from their employer.
Watch Employee Carefully
If you decline an employee’s request for a loan, make sure to watch the employee carefully. The stresses related to the fraud triangle may have increased by you saying “No,”, and the employee may get desperate.
When an employee comes to you asking for help, this opens the door to a frank, and what can be, healthy discussion regarding their personal finances. Make sure you are well aware of the circumstances that have put the employee in this situation. Your understanding will help you not only make the correct decision, but also help the employee with more permanent solutions. This is also an opportunity for you to evaluate the employee’s compensation. Many employees do not know how to ask their employer for a raise, it it may be that they’ve earned it.
5 Keys to Lending Money to Employees:
1. Make sure there is a specific need. Ask your employee to provide a bill or invoice related to the money they are borrowing. This helps the employee understand you are helping them with a specific need and not just dolling out money.
2. Limit the number of times employees can borrow. Limiting the number of times an employee can borrow accomplishes two goals: First, it encourages the employee to fix the financial problems in their personal life because you’ve eliminated a crutch for them to turn to. Second, you limit the potential personnel problems that can accompanying employee lending.
3. Charge interest. Employees may come to an employer because they won’t have to pay interest like they would at a “payday loan” company. A common action by those in personal financial difficulty is to seek out lending sources with the “cheapest” money. By charging interest you show your employee your company’s money is just as valuable as that of anyone else, and you avoid employees taking advantage of you. Make sure you abide by any related state laws.
4. Require employee to sign a note with repayment terms. For the safety of the company, and to ensure the employee understands the severity of borrowing from the company, formalize the arrangement by drafting a note payable to the company and require the employee to sign it. Make sure to include the repayment terms, interest rate and actions if employee defaults.
5. Draw a hard line from the beginning. Whatever your stance on lending to employees, you will be better off if you define the boundaries in which you will lend and stick within them. Employees in desperate financial situations will become like children; they will push the boundaries to get as much as possible. As a good parent would do, employers need to stand firm and act in a way that is best for the employee.
6. Follow through on your side of the agreement. If the employee defaults on the agreement, follow through on the default terms specified in the note signed by the employee. These actions may include automatic deductions from the employee’s paycheck or legal action if the employee has quit.
7. Don’t overestimate loyalty. A person in financial distress may do irrational things. The employees who can do the most damage and cause the most pain are those you feel are most loyal.
8. Don’t do anything that will jeopardize your company or other employees. This needs no more pontification.
In our role as employers it is sometimes difficult to make hard decisions that are more beneficial for the employee than he or she may realize. Again, it’s like being a parent. When you involve an employee’s personal financial matters, it gets even more complicated. It’s always best to err on the side of what benefits the overall business and what is best for the employee.
Business owners: Have you ever loaned money to one of your employees? Employees: Have you ever asked for a loan from your employer? If so, please share your experience: