Small Business and The Personal Guarantee
Over 99 percent of America’s 28.7 million firms are small businesses. Forty eight percent of all US employees work for small businesses. Despite the economic clout of small business, many lenders still tend to view loans to small businesses, particularly start-ups, as among the riskiest they make, especially when there is a short credit history and uncertain business revenue on which to base their decision.
Lenders try to mitigate their risk by requiring small business owners to sign personal guarantees as a condition for lending money. If you’re a small business owner, and you’ve borrowed operating capital, or signed a lease, you’ve likely encountered a personal guarantee. A personal guarantee is a legal agreement by the business owner to repay a business debt if the business is unable to repay it. These guarantees put the personal assets of small business owners at risk—savings accounts, cars, homes and retirement funds. So, while they may be a necessary evil for small business borrowers, there are creative ways to minimize the business owner’s exposure to risk. Here are some ideas:
1. Request limitations on when the guarantee goes into effect. Try to include terms allowing the personal guarantee to be utilized only once a certain number of payments have been missed or if the net worth of the business decreases below a specific amount.
2. Ask for the personal guarantee amount to be decreased over time, as the business grows. As your business grows, it should stabilize and establish good track record of paying its bills on time. As the business establishes its credit, the amount of the personal guarantees can be reduced.
3. Ask the bank to put some “skin in the game”. There’s no rule that says the bank shouldn’t have some risk. Seek a ceiling on the amount of your personal guarantee that is less than the total amount borrowed.
4. Seek to limit the personal guarantee based on ownership percentage. Unless you negotiate other terms, lenders are likely to try to establish an unlimited personal guarantee. They want to be able to collect the entire outstanding loan amount, as well as attorneys’ fees, from any one of the individual business owners, even if there are multiple owners. It is important to avoid this “joint and several” liability, which allows the lender to recover the full amount from you if the other owners no longer have sufficient personal assets to cover the loan. Even if you only own half the business, the lender wants you on the hook for the whole loan amount. It is possible to negotiate a limit to your owner’s personal liability based on your ownership percentage in the business.
5. Request to exempt certain assets, such as your home or retirement account, from the scope of the guarantee. Some states have homestead statutes that exempt primary residences from being sold to meet the demands of most creditors or limit the amount creditors can recover from the sale. You can negotiate the exclusion of certain assets from your guarantee.
6. Trade a higher interest rate for a personal guarantee. Nobody likes to pay more interest than necessary, but if it means protecting some or all of your personal assets from risk of loss, it may be worthwhile to pay a little more interest and eliminate the personal guarantee.
Lenders are almost certain to include terms in small business loans providing extensive personal liability for the business owner. Experienced legal counsel can explain the full ramifications of a personal guarantee before you commit. Also, in a competitive lending marketplace, where lenders want to lend you money, personal guarantees may be negotiable.
The Knee Law Firm, Ltd. can help you negotiate terms that will minimize your liability and maximize protections for your assets (and your credit rating). Connect with us today to set up a meeting.
Contact Bill Knee at 847-807-5633