Personal Guarantees - What You Need to Know Before You Sign
If you're looking for a credit facility for your business, be prepared to give a personal guarantee. There is almost no lender today that does not require personal guarantees from the principals of the business as security, especially from small to medium-sized businesses. Unless you're doing in excess of $10 million in annual revenues, a personal guarantee will be a pre-requisite.
For a start-up, a business loan may be your only means of getting the operation off the ground. So if you find yourself with no other option, you may have to bite the bullet and sign that guarantee. Just make sure you know what the risks are before you do that.
Understanding Your Exposure
The following is a list of the obligations and potential risks you are agreeing to when you put your signature on a personal guarantee.
- You're co-signing for the company in order to secure the loan. That's what a personal guarantee is – it is your personal assurance to the lender that the loan will be repaid in full, including accrued interest and any other amounts that are payable on the debt. If the company can't meet its financial obligations, it will have to come out of your pocket.
- Your personal assets are at risk. The lender can seize your personal assets – including your home, your bank accounts, investments, stocks and bonds, vehicles, revenue properties, etc. – to pay off the debt.
- If the business fails, you're still liable. If the company files for bankruptcy or goes into receivership, and the proceeds from liquidating the assets is not enough to pay off the debt, you may still be stuck with settling the balance.
- You could be held responsible for all of the debt even if you don't own all of the company. If you read over the Personal Guarantee form, you'll see that it contains a "joint and several" clause. This means that if there is more than one guarantor, all of them are jointly and severally liable for all of the debt. So even if you own half the company, you could be liable for repaying all of the debt if your partner defaults on paying his share.
- You're agreeing to pay more than just the principal amount. Don't forget about the interest, late fees, penalties, and collection fees and legal costs if the matter goes to court. All of those amounts form part of the indebtedness you're promising to pay.
- Is the guarantee a continuing guarantee? A continuing guarantee has no termination date. If you want to terminate it, you'll have to pay the outstanding balance.
- Repayment of the debt could be ruinous. Ask yourself how you could afford to pay off the debt if the lender took action on your guarantee. Would you be able to come up with the cash to cover it? Would you have to sell off all of your personal assets? Would you have to declare personal bankruptcy? How would all of this affect your family and your future?
Take Steps to Protect Yourself
- If you're not the sole owner of the business, negotiate with the lender to limit your guarantee to the same proportion of the debt as your ownership of the company. So if you're a 25% owner, you would guarantee 25% of the debt.
- Always review the paperwork with your lawyer before signing. He/She can answer all of your questions and explain the language and uncover the risks that could arise from the guarantee.
- If your landlord is asking for a lease guarantee, offer to pay a security deposit instead.
- Ask the lender to limit the guarantee to the first 2 or 3 years of the loan or, if the credit is a revolving line, to add a "sunset date" to eliminate or reduce the scope of the guarantee once the business has established its creditworthiness.
- Get personal guarantee insurance for your business. There are a number of companies who provide this type of insurance, so shop around and do a comparison of rates, features and options.
Don't give a personal guarantee if you don't have to. But if it is unavoidable, do your homework. Learn what the risks are, and what you could be in for if the business can't pay its debts. Forewarned is forearmed.