Updated: Sep 27, 2022
In part one, Remarkable Truth About Personal Guarantees, we explained what a personal guarantee is and the risks that they present to the business owner. They are the business owner’s kryptonite. Now we’ll give you proven ways to limit or even avoid personal guarantees.
Situations Where a Personal Guarantee is Virtually Guaranteed
There are some contracts where you are very, very unlikely to avoid a personal guarantee as a small business owner. Most commercial loans will require a personal guarantee and its non-negotiable, especially with larger lenders. Unless you are a major national tenant, commercial leases typically require a personal guarantee. Seeking to sign a franchise agreement? You’ll be signing a personal guarantee almost without a doubt. You can certainly ask to limit or not include a personal guarantee in these situations. We’re here to tell you that you should not get your hopes up. We’ve accomplished this for clients on occasion but not very often.
Knowing When to Just Say “No”
We suggest that you avoid signing a personal guarantee for current or past debts. You may be tempted to do this in order to avoid the creditor pursuing collection. This is usually a bad idea. There’s a reason why you’ve not paid the debt. Its unlikely that circumstances are going to change so dramatically so as to enable your business to come current on the debt. You get nothing in return for giving this type of guarantee. There is really no good reason to put your personal assets at risk in this type of a situation.
If you’re signing as a the owner of a minority shareholder in a business, you should really think twice before you sign. These are some of the worst guarantees to give. You have no control over the business decisions being made, including how the money is being spent and what bills are being paid. Even though your control is limited, your personal liability is not limited as between you and the obligee. The bank or the vendor can collect the entire amount due from you or any of the guarantors. The obligee is not required to seek payment from the business or the majority owners before seeking payment from you. Your co-borrowers are not obligated to reimburse you for amounts that you pay on the guarantee (unless you have a specific agreement to that effect). They probably cannot pay you anyway because if they could pay you, they would have paid the underlying debt in the first place.
Before signing a personal guarantee as a minority shareholder, we cannot understate how important it is for you to give a lot of thought to signing. You might suggest that your company purchase personal guarantee insurance for you. Seek professional advice from an attorney for options to protect yourself.
How to Limit a Personal Guarantee
Although it can be difficult to entirely eliminate the need for a personal guarantee, you may be able to limit its scope by taking the following steps:
Refuse to sign or simply cross out the guarantee language. This sounds ridiculously simplistic but frankly, sometimes it works. This is especially true for vendor and supplier credit applications and “small print” contracts that are presented to you. The other side is not always passing these past their legal counsel and may either not notice or even care that you marked up their form. Their review might only go so far as looking to see that you signed the form somewhere. Make sure you retain a photocopy of what you signed and returned. It would not be the first time a vendor “corrected” a contract after the fact without telling you and you see it the first time they try to collect on an invoice.
Define when the personal guarantee would go into effect. This could be based on the number of loan payments missed, the amount of working capital of the business, or the net worth of the business falling below a specified amount. Also, consider requesting business days vs. actual days to give yourself more time for reporting and the ability to respond to changing circumstances.
Decrease personal guarantee with improved business performance or passage of time. You can request the personal guarantee be reduced when business grows and the company becomes more stable. You can also ask that the amount guaranteed decrease as you make timely repayments. You can ask that the guarantee “sunset” (become void) after the passage of a certain amount of time during which you have made time payments.
Limit a guarantee. Banks will always want an unconditional or unlimited guarantee. The business owner should start by requesting that the amount of the personal guarantee be limited either by the actual dollar amount or by a percent of the outstanding loan. If there are multiple owners, you can also seek to limit the amount of exposure by the percent ownership for each partner.
Revoke old guarantees. You can revoke your guarantee for future purchases or orders with vendors to whom you previously gave a guarantee. You should write a letter to the obligee stating such. If your contract with the vendor or contracting party contains specific notice requirements, you should carefully follow those. Its best to send it via some type of hard-copy mail with a proof of mailing. Again, retain a fully executed copy of what you sent to the vendor.
Suggest terms of relief. You can ask to be relieved of the personal guarantee after a certain percent of the loan has been repaid or your share in business has been sold.
Modify the reporting requirements. Lenders typically require guarantors to submit personal financial information at least annually. This is one of the ways for banks to locate and request personal assets. You can provide personal financial statements with the minimum acceptable disclosure.
Avoid “joint and several” language if possible. Ask to limit who will guarantee the obligation. If there are multiple partners, try to avoid a joint and several personal guarantee. Push for an indemnification guarantee.
Don’t cover more than 100 percent. Suggest that each partner carry a percentage of the guarantee rather than each partner carrying 100 percent – state laws may vary on the ability to do this.
Try to eliminate certain assets. Request that certain assets, such as your personal residence or stock in the business, be outside the reach of the guarantee. You can suggest that your personal obligation be capped at a certain percentage of your net personal wealth. You can also offer alternate security for the debt. For example, if you have more than one business entity, you can suggest that your other business, rather than you, be the guarantor.
Higher interest rate. Evaluate the option of paying a higher interest rate in exchange for no personal guarantee or limited guarantee.
Do not include spouse as a guarantor. It is strongly suggested not to agree to a requirement of having the spouse as a co-signer on the personal guarantee. This provides both spouses with some protection, because personal assets under the spouse’s name will not be included, should the personal guarantee be called.
Personal guarantee insurance. Personal guarantee insurance can protect your personal assets. With this coverage, you can limit personal risk to a more acceptable level.
Get Legal Advice Before Signing a Personal Guarantee
While many lenders or other vendors require a personal guarantee when making some business loans and other contracts, it’s usually possible to negotiate at least some of the terms. Our business attorneys can help you understand the provisions of a personal guarantee and provide ideas for negotiating one that fits your needs.