Why Do I Need a Personal Guarantee for a Commercial Lease?
When I talk to people who are getting ready to buy or start a business, they often tell me that they are being required to give a personal guarantee to lease commercial space for their business. Most business advisors say you should keep business and personal financial matters separate. The loan is for the business, not for the individual. So why is this personal guarantee needed?
Why Do I Need a Personal Guarantee for a Lease?
Before a bank lends money to a startup business, they often require that the business provides 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.
In the past, this requirement for a personal guarantee on a lease was not common, but since the recession in 2008, it's become much more common. 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.
If you are asking for major upgrades (tenant improvements), this is a big cost for the landlord that may not be applicable to the next tenant, so the personal guarantee means the landlord can get some of this cost back.
A Real Estate Attorney Discusses Personal Guarantees
I asked Susan Dawson, an experienced leasing attorney with Waltz, Palmer, and Dawson, for her comments. Susan said:
There was a time when landlords were willing to negotiate leases without personal guarantees. With the commercial real estate industry collapse, those days are long gone. Landlords may be more willing to negotiate on rents and common area maintenance (CAM) charges, but one thing they will insist on is a personal guarantee.
When a business enters into a lease, usually the lease is signed by any officer on behalf of the corporation. If the business fails and defaults on the lease, the landlord is out of luck. Which is why landlords now 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 - Unsecured Guarantees
A personal guarantee, almost by definition, is unsecured. That is, there is no specific piece of property that can be used to pay back the loan. It means you are putting personal property at risk by signing this agreement.
Negotiating a Personal Guarantee on a Commercial Loan
Just because landlords 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. A new landlord may ask for the recovery of all rent for the total lease period, plus costs for tenant improvements. 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 landlords simply want you to establish a track record. So if you're signing a five-year lease, you can ask that the guarantee only lasts for the first three years.
If you have the financial resources, you can also offer to put a letter of credit in place for a set dollar amount, and the letter can be tapped if the property is abandoned.
You could offer to guarantee rent for a set period of time after early termination. If a tenant breaches a lease with three years remaining, the landlord has to try to lease the space to someone else. Courts usually will not award the landlord the right to recover all three remaining years worth of rent.
The 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 up front, saying you'll agree to guarantee 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 up front.
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.
There are other lease negotiation alternatives. A combination of limiting the time and amount of the lease could be negotiated, in exchange for some other types of guarantees you might be able to give, such as a longer lease period. A creative broker or lawyer should be able to help you with some other ideas.
If you are asked to sign a personal guarantee for a business lease, knowing what is involved in this guarantee and being able to negotiate terms can help you minimize your personal financial exposure in this situation.