But a subset of parents, many quite wealthy, is responding not with handouts but with loans that children apply for and that require approval by parents, relatives, or even people outside the family, as they would at a bank.

These families are working to support their children’s interests without robbing them of motivation, causing rifts among their siblings or even running afoul of the Internal Revenue Service, which may wonder whether these loans are really gifts.

“My advice is to start early and small and allow it to grow,” said Warner King Babcock, chairman and chief executive of AM Private Enterprises, a registered investment adviser in New Canaan, Conn.

Mr. Babcock, a chemist by training, knows whereof he speaks. When he was in his early 20s and working for his father’s engineering and construction materials company in Greenwich, Conn., he got an idea for a type of waterproofing that would work in extreme conditions. His father backed the idea financially, and Mr. Babcock patented and began selling the coating.

The company sold its high-performance coatings to clients like zoos and nuclear power plants. But seven years into the venture, Mr. Babcock told his father that he was leaving, even though the company was doing well.

Today, he chooses his words carefully so as not to offend his siblings.

“I felt early on that I had a lot of freedom and I was empowered to grow the firm,” he said. “As time went on, I felt that there was more involvement in the key decisions, and it got to a point where that caused friction. If there was an outside board that could have acted as a buffer, that would have helped.”

That experience informed his later work as an investment adviser to large, wealthy families.

Mr. Babcock is trying to share the benefits and perils of what is often called the family bank with a wider audience. In this, he is part of a small group of advisers that sees formal lending in a family as a way to invest in ideas from younger generations, provide financing when real banks may be hesitant and teach lessons about stewardship and responsibility.

Here’s some of what families of more modest means can learn.

HOW TO DO IT RIGHT Parents hardly need to be told that their children are having trouble supporting themselves after finishing school. But a recent report from Junior Achievement and the Allstate Foundation said that the number of high school students expecting to be financially dependent on their parents into their late 20s had more than doubled in the last two years, to 25 percent from 12 percent.

According to the report, parents have also resigned themselves to offering some level of financial assistance through those years. The parents cited the poor job market and economy, and changing societal norms.

This is where loans in a family may be a way of supporting a child’s idea without making it seem like a handout.

Whether a family is making a $10,000 or a $1 million loan, the most successful lay out criteria for lending. They could say that loans will be made for business ventures, investments or a mortgage on a house, but not for living expenses or travel. They could require everyone to submit a business plan.

“If you have a family bank set up where there is a system or a process for asking the family for loans, it cuts out all the issues of people asking for money and saying you like my sister better,” said Mindy Rosenthal, president of the Institute for Private Investors, an organization that recently hosted a seminar on the Web about family banks. “All the processes and procedures cut out all this family dynamics.”

From there, the loan should include language explaining that it must be repaid and what will happen if the endeavor fails.

Mr. Babcock said he knows of one family that requires collateral before making a loan. Others, he said, require periodic updates on the business and reserve the right to offer advice or renegotiate loan terms if the business is struggling. If the loan can’t be repaid, Mr. Babcock said a family that had documented it could write it off the way a bank would.

HOW IT GOES WRONG As with anything in a family, there are many ways that lending money to relatives can end badly.

Article source: http://www.nytimes.com/2013/06/01/your-money/a-building-and-loan-built-on-the-family-tree.html?partner=rss&emc=rss