Over the next year, 61 percent of small business owners expect to expand their businesses. For many that will mean they will be in search of capital. What may surprise them is they may be required to sign a personal guarantee to secure financing. Below are seven things you need to know about personal guarantees.
- What is a personal guarantee? A personal guarantee is an unsecured written promise from a business owner and or business executive guaranteeing payment on an equipment lease or loan in the event the business does not pay. Since it is unsecured, a personal guarantee is not tied to a specific asset. However, in the event of non-payment a lender can go after the guarantor’s personal assets.
- Why do lessors and lenders require a personal guarantee? Many lenders require a personal guarantee as an “added assurance” that the owner or executive is committed to the business and is committed to repaying the equipment lease or loan. A personal guarantee demonstrates to a lessor or lender that you are a responsible business owner and intend to repay all of your business leases and or loans. The general rule is that any holder of 20% or more of the equity of a business must personally guarantee the lease and loan obligations of the business. In most cases a small- or medium-sized business owners’ personal finances are intertwined with the business, so it is reasonable that a lessor or lender would want this assurance. From the lessor or lender’s viewpoint, if the owner isn’t willing to stand behind the business, then why should the lessor or lender take a risk?
- Why is the spouse required to sign in some cases? For the same reason a business owner is. Since in most cases a small- or medium-sized business owners’ personal finances are co-mingled with the business, so is the spouse’s finances.
- Are all small- or medium-sized businesses required to sign a personal guarantee? Not all SMBs are required to sign. The exceptions include large, well established SMBs with revenues exceeding $25 million; public companies registered on a public stock exchange like NASDAQ; non-profit companies; venture-backed companies; and businesses structured as ESOPs. A good rule of thumb, though, is that if your primary bank requires a personal guarantee for a 12 month revolving loan, then a lessor or lender providing a 3 to 5 year term lease or loan (involving more risk because of the longer term) will certainly require it.
- When should you NOT sign a personal guarantee? Be careful about signing a personal guarantee if you are not part of the executive management team and do not really have a full view of the company’s plans or finances. If you are unsure, consider having your lawyer review the document.
- What does a personal guarantee include? The personal guarantee will declare that you are personally liable for the lease or loan obligations of your business and may also declare that you are liable for default interest, legal and other fees.
- What if you sell the business? In the event you sell your interest in a business, you need to make sure you get your personal guarantee released. If you are not properly released from the personal guarantee you will still be held liable if the lease or loan goes into default. You may be required to pay off the lease as part of the sale of the business.
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