How can I avoid or limit signing a personal guarantee for business debts?

Another post here explains what a personal guarantee is, and why it’s so risky to offer one. But personal guarantees are like kryptonite to small business owners, so this post will focus on proven ways to limit the need for one - or avoid them altogether.

A Personal Guarantee Is Almost Unavoidable

There are some situations where a personal guarantee is almost unavoidable, like most commercial loans. Most of the time, if your deal is with a larger lender you’re not going to have much luck negotiating this point. Commercial lease agreements with landlords (unless you’re a large national tenant), and almost all franchise agreements also fall into this group. It’s not a bad idea to ask, but don’t get your hopes up.

There are some situations, however, where you should just flat out say no. Here’s a classic example: a creditor is hassling you about an old debt (or one you owe that you’re past due on), but they agree to back off - if you’ll sign a personal guarantee. DON’T. The odds you’ll end up in a position where you can repay a loan or debt like this are extremely long, and you get nothing in return for putting your personal assets in harm’s way.

Limited Control Does Not Equal Limited Liability

If you own a minority share in a business, that’s where personal guarantees get ugly. As a minority owner you don’t get to decide what gets spent or how bills are paid, but just because you have a limited stake doesn’t mean your potential liability is limited. A lender or vendor is allowed to recover the entire debt from just one guarantor, regardless of their percentage of ownership in the company. A creditor doesn’t have to go after the business itself or any majority owner first - as long as the debt’s secured by a personal guarantee, they can collect everything from you alone. If you’re repaid by other owners it’s because they agreed to it, not because they had to.

If you’re ever asked to personally guarantee a business debt as a minority owner, be sure to think it through very carefully and don’t rush into anything. You should also ask the company to buy guarantee insurance to cover you, and consult with a lawyer to run you through other options you have to protect yourself.

Proven Strategies

Getting rid of a personal guarantee entirely is often challenging. But there are several proven strategies you can use to limit the scope of a guarantee.

The first thing you can do to avoid a personal guarantee is to just say no - don’t sign the guarantee or strike the guarantee language from the contract. Sometimes that will work, especially with vendor credit applications and other fine-print forms that the other party won’t always submit to their lawyers. Be sure to keep a copy of what you actually return to the vendor, however. A vendor can change the form they return to you and you might not know that until they try to collect an invoice.

You can also add triggers to the guarantee so that it doesn’t go into effect unless certain events occur. An example is a contract clause that says the guarantee only takes effect after a certain number of loan payments are missed, or if the company’s working capital drops below a set amount, or if your personal net worth is less than a specified figure. If the number of days are involved, always negotiate for business days rather than calendar days. It means more time for you.

Require that the guarantee decreases as the company grows and stabilizes over time, or that the guarantee decreases as you make timely payments. Better yet, negotiate for a ”sunset” provision, in which the guarantee is voided once a certain amount of time passes with timely payments.

Cap the guarantee. Banks will almost always demand unlimited, unconditional personal guarantees and will lean hard to get them. Negotiate a dollar limit on the guarantee, or a percentage of the outstanding loan. If there are several partners in a business, ask to limit each partner’s guarantee to their share of ownership.

You can revoke a guarantee you previously gave to a vendor, but the revocation is only for future purchases or orders. If you want to revoke a personal guarantee with a vendor you should include it in a written notice and follow the vendor agreement’s notice requirements to the letter (for example, how to give the notice and to what address). You should mail a hard-copy notice to the vendor, use trackable mailing and keep a signed copy for your records to prove that you gave the notice.

Negotiate terms for getting out of a guarantee. You can do this by requiring that you be released after paying off a portion of the loan, or when you sell your interest in the business.

Limit the personal financial information you disclose. Lenders typically want to see guarantors’ personal financial statements annually. These documents help a bank discover your assets. Only provide the minimum information the lender will accept.

Stay away from joint and several liability with partners. And restrict who is required to guarantee the debt. Try to negotiate for an indemnification guarantee.

Different state laws may apply to splitting the guarantee by each partner’s ownership percentage, so you’ll have to research if it’s viable where you live.

You can protect specific assets by excluding your home from a guarantee, or your stock in the business. You can also limit the guarantee to a percentage of your net worth. You could also offer other security to the lender. For example, maybe you own a separate business that can act as guarantor.

Think about a higher interest rate if the creditor will waive or limit your guarantee.

If the lender is asking your spouse to sign on as a guarantor, this is a good place to use the strongest language possible: Do not do this. Refuse. When your spouse is not a guarantor, assets under your spouse’s name are not included when a guarantee is called.

Finally, you can consider getting insurance that will protect your personal assets, while limiting your guarantee liability to something you can live with.

Before agreeing to a guarantee, consult with a lawyer.