As lawyers counseling small business owners we typically counsel to sign agreements as an officer of the business entity rather than in your personal capacity so as to avoid personal liability in your business dealings. This is not always possible, particularly when negotiating with lenders who view loans to small businesses, particularly start-ups, as among the riskiest they make. This is particularly true when there is little or no credit history or business revenue on which to base their decision. Under these circumstances, negotiating a personal guarantee may prove necessary.
The Personal Guarantee
To reduce their risk lenders often require small business owners to sign personal guarantees as a condition of the loan. A personal guarantee is a legal commitment by an individual business owner to repay a business debt if the business is unable to repay it. These guarantees put the personal assets of small business owners at savings accounts, cars, homes, and retirement funds.
Negotiating Better Terms
Rather than simply accepting the terms as presented, negotiating the personal guarantee language so that it is still protecting the lender’s interests reduces the risk you face. There are several ways you can minimize your liability.
Personal Guarantee Triggers
1) Request limitations on when the guarantee goes into effect. Try to include terms allowing the personal guarantee to be utilized only once a certain number of payments have been missed or if the net worth of the business decreases below a specific amount.
Reduction in the Guarantee Amount
2) Ask for the amount of the personal guarantee to be decreased over time as the business grows. Once your business has stabilized and established a good track record of creditworthiness, the amount of the personal guarantee could be reduced.
Personal Guarantee Tied to Ownership Percentage
3) Seek a limited personal guarantee based on ownership percentage. Unless you negotiate other terms, lenders are likely to try to establish an unlimited personal guarantee. This allows the lender to collect 100% of the loan amount, as well as attorneys’ fees, from an individual business owner, even if there are multiple owners. It is important to avoid this “joint and several” liability, which allows the lender to recover the full amount from you if the other owners no longer have sufficient personal assets to cover the loan. Even if you only have a 50% stake in the business, you would be personally liable for the entire amount of the loan. Instead, seek to limit your personal liability based on your ownership percentage in the business.
Excluding Specific Assets from the Personal Guarantee
4) Ask for certain assets, such as your home or retirement account, to be expressly excluded from the scope of the guarantee. Some states have homestead statutes that exempt primary residences from being sold to meet the demands of most creditors or limit the amount creditors can recover from the sale.
Higher Interest Rate With No Personal Guarantee
5) Agree to pay a higher interest rate–you may be able to eliminate or limit the need for a personal guarantee by doing so. It is important to evaluate the pros and cons of a higher interest rate, however, as the profits your business generates will be reduced by higher interest payments.
No Business Entity Protection
Bear in mind that even if you have established a business structure providing limited liability protection such as a corporation or LLC, that structure will not protect you from liability under a personal guarantee.
Using Legal Counsel
There are many issues unique to small business lending that you must understand before signing a loan agreement. Lenders are likely to include terms in small business loans providing extensive personal liability. It is essential to seek legal counsel to explain the full ramifications of a personal guarantee before you sign any loan documents. We can help you negotiate terms that will minimize your liability and maximize protection for your assets and your credit rating.
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