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Pitfalls of co-signing a loan
Dear Small Biz Adviser:
I have been asked to co-sign a loan of $350,000
with a person who is purchasing a day-care business for $150,000.
Since it appraised at $350,000, she wants to get money for repairs
and whatever. She has not offered me any of the money. If I am going
to co-sign, should I not get something? Is this a wise thing? Apparently,
she needs a co-borrower because her credit score is not good enough.
Thank you.
Janet
Dear Janet:
All kinds of alarm bells started going off in my head as I
read your inquiry. To begin, I assume your definition of co-signing
is to repay the debt, as a guarantor, if the buyer fails to do so.
The other type of co-signer is one in which both signers are participating
in the ownership of what is being purchased.
Based on the assumption you are signing to repay if
the buyer fails to do so, your brief description raises the following
concerns:
- This person does not have a credit rating sufficient
to secure the loan on her own account.
- Do you know the reason for the buyer's apparent
lack of sustainable credit history for a loan of that size?
- You are being asked to co-sign on a loan for $350,000.
Yet, you can't tell me the specific costs for which this lady
intends to use the $200,000 above the purchase price.
- Similarly, you apparently have not seen any business
plan or other documents that detail the purchase and other uses
of funds, projected sales projections or any other item that describes
and substantiates the potential to operate a profitable venture.
- You do not indicate why the present owner is selling.
That is the first question I always ask. I want to know if the
seller is "bailing out" or if there is some other reason
for which he or she no longer wants to own the business.
- What is the nature of the relationship between
you and the purchaser? For example, how long you have known her?
- What is the purchaser's entrepreneurial experience:
successes, failures, level of personal or professional responsibility?
- If the buyer defaults on the loan, you are completely
liable if she cannot settle accounts to the complete satisfaction
of the lender.
Need I go any further? You don't even know if she
has been informed that a co-signer will suffice to secure the loan.
And I don't even know if you would qualify as a co-signer.
Last, but definitely not least for your consideration,
if the buyer defaults on the loan and files bankruptcy, you are
not protected. The lender can still seek you out for repayment on
the loan. The only exception would be Chapter 13 bankruptcy, but
that refers to individuals, not business.
Before signing on the dotted line
I suggest you do the following before deciding whether to act
as a guaranteeing co-signer:
- Have the buyer give you the specific reason for
her need of a co-signer.
- Clarify the status is that of a guarantor, unless
she wants you to actually participate in the business.
- Ask to see the purchase agreement, her business
plan and the actual loan-application documents. You want to confirm
all the facts she is conveying. Is the purchase price actually
$150,000? What are the intended uses for the remaining $200,000?
- Ask to see a list of all collateralized assets,
original value, present value and representative percent of the
total collateral value. You want to know what the lender has to
rely on for asset liquidation in the case of default.
- Ask to speak directly with the lender, and have
the buyer present at the meeting. You want all your questions
addressed by the lender in the presence of the buyer.
- Visit the day-care facility. An actual site visit
may uncover details, facts and other conditions not conveyed to
you by the lender or the buyer.
- Ask to know why the seller is selling. You need
to know this is not a "bailout" situation.
Do not misunderstand my position in this matter. I
am not saying you should co-sign as a guarantor on the loan. I am
simply noting actions you should take if considering co-signing.
I sincerely wish you the best in this matter, especially
if the buyer is a family member or a friend. Saying no can negatively
impact personal relationships.
-- Posted: April 4, 2002
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