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With personal guarantee loans, you bet it all
By Jay MacDonald
Bankrate.com
 Are
you willing to bet the house on your small business loan?
In all likelihood, that's exactly what most
banking lenders will ask you to do before offering you a commercial
loan.
Even if you have flawless credit.
Even if you are incorporated.
Even if you are certain that your upcoming IPO
might enable you to buy the bank itself.
Tucked inside your loan packet these days,
you'll probably find an unassuming document called a personal guarantee.
Your goal as a shrewd business owner is to
avoid signing it, or failing that, to limit its impact on you, your
spouse, your partners and your co-signer in the event that unforeseen
circumstances force you to default on your commercial loan.
What is a personal guarantee?
When you sign a commercial loan, you obligate your company to pay
the money back with interest over a specified period.
Before offering you a commercial loan, the lender
will require sound credit and solid financial indicating that your
company can indeed generate enough profit to make good on the loan.
Moreover, they'll also require collateral, a secondary source of
payment should your business encounter difficulties meeting its
loan obligation.
In addition, most banks today require a personal
guarantee:
- To ensure they can recover the loan balance
by liquidating your personal assets as well as your corporate
assets in event of default;
- As a show of your good faith and commitment
to repay the loan; and
- Because they can.
A personal guarantee, as its name implies, designates
specific individuals who will pay any deficiency (shortfall) on
a loan. That most likely will include you as owner; your spouse;
your partners and their spouses; any co-signer with the wherewithal
to make the bank breathe easier; or all of the above.
Personal guarantees might be capped at a fixed
dollar amount or unlimited; banks usually require the latter. Most
personal guarantees provide for "joint and several liability," which
means that any signer can be held responsible for 100 percent of
the loan deficiency, regardless of their stake in the company.
And most loan documents allow the bank to recover
payment in any order it chooses, meaning that if your company defaults,
they can come for your personal assets directly without first liquidating
corporate or collateral assets.
"Personal guarantees are really there for the
business owner to say, 'Look, I'm really standing behind my company,
I have faith this is going to work and I want you to have faith
that it's going to work,'" says Lisa Oliver, Northeast regional
sales manager for Key Bank.
"That translates into, 'I'm not worried about giving you my guarantee
because there's never going to be a problem with my business, I'm
behind it 200 percent and I'm not going to make any rash decisions.'"
Why should I avoid them?
Personal guarantees are great for the lender, not so great for you.
"Personal guarantees from a debtor's point of
view are always a problem," says bankruptcy attorney Richard Hollander
of Miller
and Hollander law firm in Fort Myers, Fla. "It's unwise to sign
one unless you really are sure you can pay the money back because
the minute you sign a personal guarantee, your house is at risk.
If you can get the bank to give you a loan without signing one,
you're better off."
Lawyers typically advise against signing a personal
guarantee because it effectively nullifies any legal protection
that you may have put in place -- such as incorporation -- to protect
your house, car and other non-business assets from liens or foreclosure
to satisfy business debts.
That's right: incorporation won't protect your
home and assets if you sign a personal guarantee.
"Small business owners seem to think that if
they're an S corporation, the business is a separate entity and
they don't have to personally guarantee a loan," says Suzanne Specht,
certified business analyst with the SBDC
at Florida Gulf Coast University. "That, of course, is not true.
Typically banks, even with Small Business Administration loans,
are going to want your personal guarantee on that loan. There is
no separation between the small business owner and the corporation."
In addition, should you default on the loan,
you could lose your domicile by signing a personal guarantee and
putting up your mortgage, whereas your house and other personal
assets might be protected should you end up filing for bankruptcy,
depending upon your state of residence.
Hedging Strategies
The fact is, both you and your lender want to make this loan work.
Neither of you wants to face a default situation.
And while your banker may not volunteer the
information, that personal guarantee can be limited and even eliminated
-- if you know how to finesse it.
Your position is that your business assets,
your creditworthiness and your character are sufficient to guarantee
the loan. That personal guarantee? Nothing more than blatant excessive
security -- security you may well need to grow your business in
the future.
Here are your goals when hammering out the loan
terms, listed from whole cake to crumbs:
- Eliminate the personal guarantee.
If your business alone has sufficient assets to cover the loan,
hold your ground. If you have had a long and successful relationship
with the bank, threaten to take your loan and/or your business
across the street; banks are keenly averse to losing business
customers these days. If all else fails, reluctantly agree to
pay a higher interest rate to eliminate the personal guarantee
if your personal exposure warrants it.
- Limit the personal guarantee. Negotiate
a realistic dollar amount or loan percentage for which you would
be personally liable. Try to win favorable capital or new worth
minimums that would trigger collection. Refuse to have your spouse
sign a personal guarantee. If these tactics fail, try to limit
personal assets that would be subject to the guarantee. (Important
note: if you are successful in limiting your personal guarantee,
make sure the cap covers principal, interest and collection fees;
otherwise, your bank may stick you for interest and collection
costs.)
- Modify your loan. Consider borrowing
less or for a shorter period to minimize your exposure in case
you default.
- Set a term for the personal guarantee.
Once the loan principal is repaid to a predefined level or payments
have been made for a certain length of time, the personal guarantee
becomes null and void.
If you are unsuccessful in obtaining a loan
without signing an unlimited personal guarantee, you have one other
weapon at your disposal: Have new partners or additional owners
sign a personal guarantee when they come on board. It won't necessarily
save your "farm," but it will give the bank more "farms" to choose
from if foreclosure becomes imminent.
In the bank's defense, Hollander notes that
the bank doesn't want your home; they'd much rather have your business
-- this one or the next one.
"Usually the bank will go after corporate assets
first; they don't like to take houses for a lot of reasons," he
says. "They know that the people they lend money to may be bad today
but good tomorrow. Just to qualify for a commercial loan you have
to be a pretty good businessman. They know you'll be back, and they
want to maintain a relationship with you."
Jay MacDonald is a contributing
editor based in Florida
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