Why Do I Need a Personal Guarantee for a Business Loan or Lease?
Business owners are often required to give a personal guarantee to get a business loan or to lease commercial space for their business. Most business advisors say you should keep business and personal financial matters separate, and the loan is for the business, not for the individual. So why is this personal guarantee needed?
Personal Guarantees for Bank Loans
Before a bank lends money to a startup business, they often require additional guarantees in case the loan can't be paid off from the assets or cash flow of the business. A personal guarantee requires the individual to pay back a loan personally in the event of default. The personal guarantee helps the lender, because startup businesses don't have a consistent history of profits and cash to pay bills.
A personal guarantee can put your personal credit rating on the line, in addition to the credit rating of your business.
Personal Guarantees for Commercial Leases
In the past, the requirement for a personal guarantee on a commercial lease was not common, but since the recession in 2008, it's become much more so. Like a loan, a commercial lease is a major commitment for a business, and the leasing company wants to know that the lease will continue to be paid up to its completion, even if the company goes bankrupt. Landlords may be willing to negotiate on rents and common area maintenance (CAM) charges, but one thing they will probably insist on is a personal guarantee.
How Personal Guarantees Work
When a business enters into a lease or loan, usually the legal documents are signed by any officer on behalf of the corporation. The business owner's personal guarantee is a separate legal agreement.
If the business fails and defaults on the lease or loan, the landlord/lender is out of luck. Lenders almost always require personal guarantees and a complete financial check on the business owner to ensure the owner has the finances to back up the guarantee.
Personal guarantees may be secured or unsecured. Security is an asset (like a car or home or savings) that can be sold or used to pay the lease if the company can't. Most personal guarantees are secured, which means you may have to put some personal assets (like a car or property) on the line. It means you are putting personal property at risk by signing this agreement.
Personal Guarantees on SBA Loans
The Small Business Administration (SBA) helps businesses find and secure loans. It doesn't loan money directly, but it acts as a co-signer, giving some guarantees to the lender. But the SBA and the lender will probably still want your personal guarantee. For their main loan program, the 7(a) loan, for example, the SBA requires that business owners who own 20% or more of their business must provide an unconditional personal guaranty. This means that even if the lender changes the terms of the loan, the personal guarantee still stands.
Negotiating a Personal Guarantee
Just because landlords and lenders require guarantees does not mean there isn't some room for negotiation. You may want to consider one of these options:
Limit the amount of the guarantee. For a lease, your landlord may ask for a personal guarantee for all costs for the lease period, including common area maintenance (CAM) costs and costs for tenant improvements (TI) (costs for improving the leased space to your specifications). This amount is definitely up for negotiation, and you might want to ask for the CAM costs to be taken out, or for the amount of the guarantee to be for only the tenant improvements.
Ask for a time limit on the guarantee. Sometimes lenders simply want you to establish a track record. So if you're signing a five-year note, you can ask that the guarantee only lasts for the first two or three years. You could also ask for a review of the personal guarantee after a year or two, to look at your business profits and cash flow and credit rating. If by this point the business is showing a nice profit, you may be able to get the personal guarantee removed.
You could offer to guarantee rent for a set period of time. If a tenant breaches a lease with three years remaining, the landlord has to try to lease the space to someone else.
Lenders are regulated by states, but landlords may not be. A court may try to determine how many months the landlord would need under the current leasing environment to re-let the space, and that's all they will award. So, by offering that deal upfront, saying you'll agree to guarantee to a limited term of 6 or 12 months, basically cuts through all of the legal negotiations and wrangling at the end and sets out the deal between the parties upfront.
Understand the law in your state. Leases, like other contracts, are subject to state laws, and sometimes local laws. The jurisdiction where the lease is to be taken if there is a contract dispute should be part of the lease agreement. Check the laws in that jurisdiction (or have an attorney do it) to make sure that your terms are reasonable and if there are laws relating to your personal guarantee.
If you don't have enough in personal assets or your credit rating is poor, you may be able to find a co-signer, someone else to give the personal guarantee. This person must have assets to pledge and a good credit rating.
If you are asked to sign a personal guarantee for a business lease or loan, knowing what is involved in this guarantee and being able to negotiate terms can help you minimize your personal financial exposure in this situation.