Experienced business owners have signed many personal guarantees, which also come in a variety of flavors. Commercial lenders regularly demand them of business owners, and sometimes of their relatives.
What does it mean for you, your partners, and your family to personally guarantee a firm’s debt? Can you do anything about it? Will a bank give you a loan without one? Often, it just comes with the territory.
Lenders Ask for Guarantees More Often than Before
Personal guarantees are nothing new in the business world. These days, with credit being tight and banks being conservative, lenders ask for guarantees more often than before.
A guarantee is a pledge by a business owner, partner, investor, or relative (the guarantor) to pay the company’s debts. It pledges their personal assets as collateral, on top of the business assets. If the company defaults, the bank can go after the guarantor’s home, investments, and bank accounts. It need not liquidate business assets first.
A called guarantee can be devastating. You owe it to yourself to plan a negotiating strategy before you meet the lender. Follow these five steps, and you will get the best deal and limit personal risk.
Step one: Understand the terms The terms of a personal guarantee can vary widely. Don’t assume that the bank only calls the guarantee if you fail to make a payment. Some even let the bank call the guarantee without an outright default. Triggers can include technical default, more borrowing, selling assets, or death or incapacitation.
Some guarantees allow the lender to demand more collateral whenever it thinks the loan is undersecured. Also, many owners believe their companies are a shield against personal liability. But once the guarantee is signed, incorporating does nothing to protect your personal assets.
Step two: Know where your co-signers stand When your partners also sign a personal guarantee, beware of joint and several liability. A guarantee that several people sign is usually written on a joint and several basis. Many borrowers assume that means that each person only has to pay a percentage. This is incorrect.
When two or more people sign a guarantee, and the lender calls it, it does not have to go after each guarantor. It can collect from whichever guarantors it chooses. Often it will choose the ones with the most liquid assets. If the lender collects the full debt from only one partner, that partner must try to collect its losses from friends or relatives who also signed the guarantee.
Step three: Decide how much risk you can take You need to understand how much business and personal risk you are willing to take before you meet the banker. Also calculate the personal assets needed to cover the guarantee. If the loan is called the company is probably having serious problems and liquidating its assets will likely yield far below book value.
Do not let your banker pressure you into doing something you cannot live with.
Step four: Bargain over the terms Almost every guarantee term is negotiable. Don’t treat it like something the lender dictates to you. Before you meet the banker, decide which terms matter to you and which ones the lender will resist. Then, plan your strategy for both the guarantee and the loan papers.
Two tactics may prove fruitful.
Your first tactic is putting a cap on it. Banks always want you to guarantee the loan unconditionally. They want unlimited exposure. See if the lender will accept a guarantee for a specified dollar amount or a percentage of the outstanding loan. Many people are not willing to risk their entire estate for the company. Partners can ask that each one’s exposure match their ownership stake.
Your second tactic is asking for conditions for release or reduction. Even if you do not cap your guarantee, you can ask to be released once a set percentage of the loan is repaid. Alternatively, you can ask that the guarantee shrink as the company’s debt-to-equity ratio improves, or after five years of problem-free payments.
Step five: Be ready to reopen talks later Don’t drop the subject just because you signed. Once the firm’s financial picture improves or you can offer more collateral, you can ask to renegotiate the guarantee. Always keep the bank informed about developments that may help your company. Give it the good news along with the bad.
Impossible to Avoid a Guarantee Completely
The bottom line With credit this tight, it may be impossible to avoid a guarantee completely. Still, you are not powerless.
These are tricky waters to navigate. It is well worth the effort to get advice from an attorney or accountant who has negotiated guarantees before and plan your bargaining strategy carefully.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
