As a small business owner myself, I have an affinity for those who choose to hang out their own shingle. I like to help small business owners minimize their risk.
One way owners of closely held businesses face personal risk is through a personal guarantee. You set up a corporation or limited liability company precisely to limit your personal risk. Now in order to get a lease or financing, you are being asked to sign a personal guarantee.
This may happen anytime in your business career, but it is particularly likely in the early years of your business. Lenders and landlords see small businesses as particularly risky, especially when the business has little or no credit history or business revenue. As a result, lenders often require small business owners to sign personal guarantees to limit the risk of a loan. By signing a personal guarantee, the business owner is legally committed to repay a business debt if the business is unable to repay it. Signing such a guarantee now defeats the purpose of the limited liability of a corporation or LLC, but only as to that creditor. That lender or landlord can now require the business owner to use personal assets to satisfy the business debt.
All is not lost, however. Here are 5 steps you can take to minimize your liability.
1) Negotiate limitations on when the guarantee is effective. Although you may not have much negotiating power in this situation, it is worth asking that the personal guarantee terms specify the guarantee is only available after a certain number of payments have been missed or if the net worth of the business decreases below a specific amount.
2) Ask for the amount of the personal guarantee to be decreased or removed over time as the business grows. I personally have done this in renewing a lease. I pointed out that my business was now established and had a good credit history and was no longer a risk. You might not wait for a renewal and instead negotiate for the guarantee to be reduced or removed after a period of time provided the business has established a good track record of creditworthiness.
3) Try to limit personal guarantee based on ownership percentage. A lender will usually ask all owners to personally guarantee all of the business debts. This is called joint and several liability. If you can, negotiate the personal guarantee so your liability is no greater than your current percentage of ownership.
4) Request that certain assets be expressly excluded from the guarantee. Many states have homestead statutes that exempt some portion of your equity in your primary residence from being sold to satisfy most debts. Here in Colorado, the exemption is pretty small, so it does not provide much protection. Instead of relying on that homestead exemption, ask that your personal residence be exempt from levy if the lender has to resort to the personal guarantee. This could also be a tactic to protect your retirement account, which may already have some asset protection.
5) Negotiate a higher interest rate or rent in exchange for removing or limited the personal guarantee. A lender may be more willing to forego the personal guarantee or agree to some of the requests outlined above if the loan itself has a higher interest rate. Likewise, a landlord may agree to similar requests if the rent is higher than market rate. However, you have to be careful as paying more as your business is starting up may prevent your business from ever getting off the ground.
Lenders and landlords will work to limit their risk by increasing your personal risk through a personal guarantee. It is wise to find an experienced small business attorney to help you understand the full ramifications of a personal guarantee before you sign anything. Call our firm today to set up a meeting to discuss the legal needs of your small business.