Personal Guarantees

Personal Guarantees

Banks like to play “games” during loan negotiations. The banker will say that a personal guarantee from all the owners of the business, and their spouses, is mandated. A personal guarantee is a pledge (by someone other than the named borrower), which he or she promises to pay off the loan if the business defaults. Most guarantee forms require that each individual who signs can be held responsible for the whole amount of the loan. Therefore, if someone is a 10 percent owner, they can be personally liable for 100 percent of the loan amount being guaranteed. Additionally, the guarantors can be sued individually or all together. Be careful, there is no requirement that the lender must show that the borrower (business) is unable to pay the loan. When you sign a personal guarantee, you become liable for the loan, even if your business is incorporated.

Some lenders make the game a "take it or leave it" situation. Everyone they want to sign a guarantee must sign one or there's no deal. This is almost always true, but if you have good collateral and creditworthiness there may be room for negotiation. This is particularly true when dealing with smaller, community banks. The banker is unlikely to tell you this because it is not in his/her best interest to do so. Unless you specifically ask, you won't really know the bank's stance on this point.

A good strategy to follow would be to always try and emphasize (but don’t lie), that your business has sufficient collateral to secure the loan and that a personal guarantee is excessive security. As your business grows and establishes a credit history, the lender's need for personal guarantees should decline. You should continue to negotiate personal guarantees whenever the business seeks additional funds. You may want to consider several factors that are negotiable in lieu of a personal guarantee. These factors are:

A higher rate of interest or points.
Borrowing a lesser amount of money.
Borrowing for a shorter period of time.
Maintenance of a higher compensating balance for the loan.
Limiting the terms of the guarantee itself such as:
Setting a fixed monetary cap
Setting a fixed percentage of responsibility for the guarantee
The exclusion of certain personal assets from the guarantee.

If you can’t avoid a personal guarantee, try to negotiate the terms of the agreement. You can try to offer a limited personal guarantee or you can try to modify the minimums that can automatically trigger the personal guarantee. Lastly, if your personal portfolio contains sufficient assets to cover the loan, and your spouse independently owns other significant assets, you should present a case explaining why your spouse's personal guarantee is unacceptable. A bank cannot force a spouse to sign a personal guarantee, but if you want the loan a hypothecation agreement is commonly required as a minimum. This agreement states that if the bank is required to act upon the personal guarantee of the business owner, the spouse has surrender his/her rights to the jointly owned property.

If your business takes on a new partner or additional owners over time you should try to get every new owner to commit to a personal guarantee on all pre-existing loans. This should be done because if an incoming partner is not personally liable for pre-existing business debts they will not share the risk for the prior commitments, but will possibly benefit from the loan. You personally should want the liability to be spread out as wide as possible. If you unfortunate enough to be required to pay on the guarantee, you may be able to seek proportionate contributions from other owners. Please consult your tax advisor for more details. You need to be aware that there may be tax consequences to existing partners when their liability for debts is reduced in this manner.

Return to The True Cost of Borrowing Money