The Denver Post
By GARY MILLER | GEM Strategy Management
September 17, 2017, at 12:01 am
Rarely can small businesses grow without needing to borrow money sometime during the company’s life. When businesses borrow money from banks, the banks almost always require a personal guarantee from the business owner or shareholders unless the business is profitable and has $25 million or more in revenues.
Most lenders require a personal guarantee as “added assurance” that the owner is committed to the business and to repaying the loan.
A personal guarantee means that if the company fails to pay its debt, you and/or your shareholders are on the hook. Personal guarantees are not limited to bank loans or lines of credit. They also include commercial leases, car loans or leases, equipment leases and other financing arrangements.
Personally guaranteeing a business loan is putting your personal finances on the line. Therefore, your credit score and assets are at risk. Make certain you fully understand what you are getting into before you sign on the dotted line.
Be aware that many business owners incorporate their businesses as C-Corps, S-Corps or limited liability companies, to ensure they have personal liability protection. But when you guarantee your company’s debt to a third party (such as a bank), you lose personal liability protection.
In addition, your personal guarantee could affect your family. Some banks require a spouse’s guarantee in addition to your own, so assets held solely in your spouse’s name are fair game for the lender. Otherwise, you might be tempted to transfer assets to your spouse’s name. In some cases (e.g., for commercial leases), you may be able to negotiate a guarantee without your spouse’s signature.
If you give a guarantee for company debt such as a business credit card, your failure to pay if the company can’t will hurt your personal credit rating. In most cases, small-business owners are required to provide personal information when their companies apply for credit cards. In some cases, if the company fails to make required payments, this action can appear on the owner’s personal credit report. This could make it difficult to borrow in the future, get a job, buy insurance or rent a place to live.
When selling your business, remember your personal guarantee survives the sale. Be sure to obtain a release from the buyer. Try to obtain a release from your lender or transfer the debt to the buyer. Alternatively, have the company satisfy the outstanding obligation before selling your interest so there’s no longer anything that you still personally guarantee on behalf of the company.
I recommend that my clients negotiate the structure of the personal guarantee as well as the loan terms and covenants with the bank. They include:
- If your company has more than one shareholder, negotiate a pro rata share of personal guarantees spread among all the shareholders based on their percent of company ownership. This arrangement limits your exposure to the percentage of the company you own. For example, if you own 60 percent of the stock of your company, you only guarantee 60 percent of the debt. If another shareholder owns 20 percent of the stock, then he or she guarantees 20 percent of the debt. According to the Small Business Administration’s standards, any individual with a 20 percent or greater ownership in a small business should be part of the loan-guarantee process.
- If the loan guarantee includes the term ‘joint and several’ – which means that each shareholder guaranteeing the loan is on the hook for 100 percent of the debt should any of the borrowers fail to pay his or her share – get rid of it if possible. If other partners can’t pay their pro rata share, the bank may demand that you pay the entire balance even if you aren’t a 100 percent owner of the business.
- If you are guaranteeing 100 percent of the loan, negotiate a guarantee with a combination of cash and collateral, which can come in the form of property, home equity, and other investments.
- If the bank requires a personal guarantee, make sure you sign a “Limited” vs. an “Unlimited” personal guarantee. When you sign an unlimited personal guarantee, you are agreeing to allow the lender to recover 100 percent of the loan amount in question, plus any legal fees associated with the loan – such as the lender’s costs for securing a judgment against you.
- If the bank loan is a term loan, five years, for example, try to limit the term of the personal guarantee – perhaps for two to three years versus the entire term of the loan.
Since banks almost always require personal guarantees, knowing what you’re undertaking is essential. Try to negotiate better arrangements that limit or even eliminate your personal exposure. Before you agree to anything, protect yourself by consulting an attorney. Make certain you fully understand what your guarantee means and what you can do to minimize your risk.
Gary Miller is the CEO of GEM Strategy Management Inc., which advises middle-market private business owners in preparing to raise capital, selling their businesses or buying companies. He can be reached at 970-390-4441 or email@example.com.