Personal Guarantees

Here's the game that banks like to play during loan negotiations. The banker matter-of-factly states that a personal guarantee from all the owners of the business, and their spouses, is mandated by their routine lending policies.

A personal guarantee is a pledge, by someone other than the named borrower, that he or she promises to pay any deficiencies on a specific loan. Most guarantee forms require joint and several liability, meaning that each individual who signs a guarantee can be held responsible for the whole amount of the loan. Consequently, even if someone is only a 10 percent owner in the business, that person is personally liable for 100 percent of the amount being guaranteed. The guarantors can be sued individually or all together. There is no requirement that, before the guarantor can be held responsible, the lender must show that the borrower actually named in the loan document, e.g., the business, is unable to pay the loan. In effect, when you sign a personal guarantee, you become personally liable for the loan, even if your business is incorporated.

Now, with some lenders, the name of this game is "take it or leave it" and everyone they want to sign a guarantee must sign one or there's no deal. However, depending upon collateral and the creditworthiness of the business, room for negotiation may exist, particularly when dealing with smaller, community banks. Naturally, the banker is unlikely to tell you this. You won't know until you test the bank's degree of dependence on this point.

Always try to emphasize, if applicable, that your business has sufficient collateral to secure the loan and that a pledge of personal assets is excessive security. As your business matures and establishes a credit history, the lender's need for personal guarantees should correspondingly decline and you should continue to negotiate the issue of personal guarantees whenever the business seeks borrowed funds. In addition, consider several other factors that may be negotiable in lieu of a personal guarantee, such as a higher rate of interest or points, borrowing a lesser amount or for a shorter period of time, maintenance of a higher compensating balance for the loan, or limiting the terms of the guarantee itself (e.g., setting a fixed monetary cap or a percentage of responsibility for the guarantee, or excluding certain personal assets from the scope of the guarantee).

If the giving of a personal guarantee cannot be avoided (and for most younger businesses, it won't be), try negotiating the terms of the agreement. Offer a limited personal guarantee, for instance, of 25 percent of the loan; or try to modify the capital or net worth minimums that can automatically trigger the personal guarantee. Finally, if your personal portfolio contains sufficient assets to cover the loan, and your spouse independently owns other significant assets, be prepared to present a case for why the spouse's personal guarantee is unacceptable. A spouse cannot be legally compelled to sign a personal guarantee; however, a hypothecation agreement is commonly required. This agreement states that if the bank is required to act upon the personal guarantee of the business owner, the spouse has relinquished his/her rights in the jointly owned property held with the business owner.


Work Smart

If your business takes on partners or additional owners over time, try to get all new owners in the business to commit to a personal guarantee on any pre-existing loans. In a partnership, for instance, an incoming partner is usually not personally liable for pre-existing business debts; absent the personal guarantee, the new partner will not share the risk for those prior commitments, although he or she may be enjoying benefits derived from that loan. You want the liability to be spread as widely as possible so that even if you are required to pay on the guarantee, you may be able to seek proportionate contributions from other owners. (However, be aware that there may be tax consequences to existing partners when their liability for debts is reduced in this manner. Please consult your tax advisor for more details.)