Make sure you thoroughly review and consider options before signing.
In the course of a business’ life cycle, many owners will need to seek financing through a loan or the execution of a lease for equipment or an office space. If you have never been in this position, you may be surprised to learn that you may be required to sign a personal guarantee to secure the financing or come to an agreement on a lease. Below are seven things that you should be aware of regarding personal guarantees.
What is a personal guarantee? A personal guarantee is a written promise guaranteeing payment on a loan or lease in the event that the business does not pay. In the event of non-payment, a lender or lessor can go after the guarantor’s personal assets. If you think about it from the perspective of the lender or lessor, they are taking a risk without getting paid up front, and they know that business owners who provide personal guarantees are more likely to make their payments.
Why do lenders and lessors require a personal guarantee? Many lenders/lessors require a personal guarantee as an added assurance that the owner is committed to the business and is committed to repaying the loan or paying the rent. A personal guarantee demonstrates to the lender or lessor that you are a responsible business owner and intend to repay all of your business loans or adhere to the terms of an executed lease. Generally, any holder of 20% or more of the equity of a business must personally guarantee the loan or lease obligations of a business. From the lender’s or lessor’s perspective, if the business owner isn’t willing to stand behind the business by signing the personal guarantee, then why should they assume this risk?
Why is a spouse sometimes required to sign? This is done to prevent the spouse from retaining all of the couple’s assets and avoiding responsibility for payment of the note as the other spouse has no assets in his or her name. This is also the reason for landlords requiring both spouses to sign as personal guarantors of a lease.
When should you not sign a personal guarantee? Be careful about being asked to sign a personal guarantee if you are not an owner or part of an executive management team and do not have a full view and understanding of the company’s plans or finances. If you are unsure, you should a lawyer review the document you are being asked to sign.
What does a personal guarantee typically include? The personal guarantee will declare that you are personally liable for the loan or lease obligations of the business and may also declare that you are liable for default interest, legal and other fees.
What if you sell your business? In the even you sell your business, or your personal interest in a business, you need to make sure that you get your personal guarantee released. If you are not properly released from the personal guarantee you will still be liable if the loan or lease goes into default.
What you can do. Build strong business and personal credit scores. This is the single best way to get away from personal guarantees. If your business already has a strong commercial credit history, you may be able to get a waiver of the personal guarantee.
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