Richard GoldsteinRichard Goldstein

The April 2017 issue of Buchbinder’s newsletter focused on personal loan guarantees. I’m sharing most of that newsletter with you, O’Dwyer’s readers, because at one time or another, personal loan guarantees will impact most public relations firms.

Lenders

Lenders always evaluate borrowers to predict whether or not they’ll repay (What else is new?). Starting a small business or PR agency is a risky proposition, and a small business start-up loan is the riskiest loan a bank can give. Even if you can get a Small Business Administration loan guarantee, you’ll most likely still be required to sign a personal guarantee. The SBA claim “All owners of 20 percent or more of a business are asked to provide a personal guarantee” in order to obtain an SBA guarantee.

For consumer loans, there are credit scores and numerous other sources of information to help with the decision. However, businesses — especially new businesses and operations that have never borrowed — probably do not have a business-specific credit history.

With limited information, it’s hard for lenders to make a decision. They would be more comfortable if they could see that you have borrowed money in the past and consistently repaid loans. When they can’t make a decision based on historical information, they require some sort of security (or they charge an extremely high rate of interest). That security comes in the form of a personal guarantee, although other approaches such as pledging business assets as collateral can be used.

The 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’s 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. By requiring a personal guarantee, lenders hope to limit the risk that their borrowers will default.

After all, if homes and bank accounts are on the line, business owners presumably will do all they can to ensure their ventures succeed. The commitment is especially important for a new business or PR agency because the bank has limited means for evaluating its performance and likelihood of success.

Limiting risk

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:

Structure when the personal guarantee would go in 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 the personal guarantee with improved business performance. You can request that the personal guarantee be reduced when your business grows and the company becomes more stable. You can also ask that the amount guaranteed decrease as you make timely repayments.

Limit a guarantee. Banks will always want an unconditional or unlimited guarantee. You should start by requesting that the amount of the 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 of each partner or owner.

Suggest terms of relief. You can ask to be relieved of the personal guarantee after a certain percentage of the loan has been repaid or your share of the business has been sold.

Modify the reporting requirements. Lenders typically require guarantors to submit personal financial statements 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 or owners, try to avoid a joint and several personal guarantee. Push for an indemnification guarantee.

Do not cover more than 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.

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’s 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.

Finally, you can try running the numbers again to determine whether you can borrow a lower amount and still have enough to operate, which should also reduce the amount of the guarantee.

While many lenders require a personal guarantee when making some business loans, it is usually possible to negotiate at least some of the terms. Your legal and accounting professionals can help you understand the provisions of a personal guarantee and provide ideas for negotiating one that fits your needs.

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Richard Goldstein is a partner at Buchbinder Tunick & Company LLP, New York, Certified Public Accountants.