If you own a small business, odds are you have signed a personal guarantee somewhere along the way. It means that if the business cannot pay, you will. Your house, your savings, your retirement – everything is on the line. So how do you get out of one? The honest answer is that sometimes it just isn’t possible, but there are ways you can protect yourself.
Certain Contracts Basically Come with a Personal Guarantee
Start with the bad news: certain contracts basically come with a personal guarantee you just have to live with. Almost all commercial loans come with one, and it’s non-negotiable with bigger lenders. Commercial leases come with one too, unless you are a big national tenant. Franchise agreements usually come with one. You can ask the lender or lessor or franchise parent to limit or waive it, but I wouldn’t count on it; we’ve done it for a client or two over the years, but hardly ever. You may think of the guarantee as a favor to the other party, but they don’t see it that way – it’s standard practice.
There Are Also Guarantees You Should Refuse Outright
There are also guarantees you should refuse outright. The first is a guarantee on a debt the business already owes. When a creditor is pressing for payment, it is tempting to sign one just to make the collection calls stop. It is a mistake. You must resist – it is not a good deal for you. There is a reason the debt has not been paid, and it is unlikely that making you legally responsible for the debt will change that. You are adding to the pressure to pay without getting anything.
The second is a guarantee you are asked to sign as a minority owner. These are some of the worst guarantees to give, because you have no control over how the company is run. The CEO can run the business into the ground and there is little you can do about it. With a minority stake, your control rights may be limited, but your personal liability is not. The bank or vendor can pursue you (or any guarantor) for the full amount—no, they don’t have to go after your business or the majority owners first. And don’t count on being reimbursed by co-borrowers; they aren’t legally obligated to you unless there’s a specific agreement, and honestly, if they could have paid, they likely would have. This is something to think about long and hard before you sign. You might ask the company to buy personal guarantee insurance for you, and you might get your way. Either way, get advice from an attorney about your options.
There Are Steps You Can Take to Limit Your Exposure
For guarantees you are willing to sign, there are steps you can take to limit your exposure. The simplest one sounds almost silly: just cross out the guarantee language, or decline to sign that part of the form. Sometimes it works, especially with vendor and supplier credit applications and small-print contracts. The people handling those forms often do not run them past a lawyer; they are not real contract negotiators and they don’t push too hard. They just want the signature. Always, always keep a photocopy of the contract you signed and sent back: vendors have been known to “correct” a contract after the fact and you end up finding out the hard way when they try to collect.
If you do have to sign, negotiate the terms. Spell out when the guarantee is triggered, too: specify a certain number of missed loan payments, a drop in working capital, or net worth falling under a certain threshold. And ask for business days instead of actual days; that buys you breathing room for reporting and to respond. You can try negotiating a reduced guarantee as your business grows and becomes more stable, along with proof that you are making your payments on time. And ask for your guarantee to sunset (become void) after a set time of timely payments. Also see if you can be relieved once a certain percentage of the loan has been repaid, or once you sell your share of the business.
You can negotiate a cap, or an upper limit, on your personal guarantee. In other words, you don’t have to pay more than a certain amount. This does not eliminate the guarantee entirely, but it may be enough to protect yourself from the worst. Banks will always want an unlimited guarantee, so start by asking for a limit, either a set dollar amount or a percentage of the debt. With several owners, the same idea applies. You can ask to limit the guarantee to your share of the business. Ask that the limit be applied on a pro-rata basis. In other words, do not hold you responsible for the whole guarantee amount if you are one of several co-guarantors. Try to steer clear of “joint and several” language when you sign contracts. Push to replace it with an indemnification guarantee. Also, don’t agree to cover more than 100 percent of anything; it’s better to have each partner cover a percentage rather than each partner being on the hook for the full amount. Be aware that your ability to do this may depend on your state’s laws.
You can revoke your guarantee for future purchases with vendors you previously gave one to. Simply write them a letter saying so. Just remember to follow any notice requirements specified in the contract and send them via hard-copy mail with proof of mailing. And keep a copy of the cancellation letter and any other correspondence. You may still be liable for any old orders that were placed before you revoked your guarantee.
Lenders typically require guarantors to file personal financial statements at least once a year. This is the bank’s way of pinpointing your personal assets. Your safest move is to turn in only the minimum acceptable information. You may be able to exclude some personal assets, such as your house or your stock in your business. Try suggesting you put a cap on your personal obligation at some percentage of your personal net worth. Offer some alternate security. If you own multiple business entities, suggest that the other business should be the guarantor rather than you.
You might want to consider accepting a higher interest rate in exchange for getting the loan without personal guarantee or a limited personal guarantee. You should definitely not agree to have your spouse sign the personal guarantee. This ensures that the spouse’s assets are not used to pay off your loan. You can buy personal guarantee insurance to protect your personal assets and ensure your personal risk is limited to a more acceptable level.
Do not be shy in asking for what you want and push back when you must. Even if you don’t get all you want, you might get some. At the end of the day, you will have to decide how far you are willing to go to protect yourself, whether through limiting your guarantee or not signing it in the first place. The best way out of a personal guarantee is not to sign one.
