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, and 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 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. Startup businesses are poor credit risks because they don't have a consistent history of profits and cash to pay bills, hence the personal guarantee.
A personal guarantee can put your personal credit rating on the line, in addition to the credit rating of your business.
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. Landlords may be willing to negotiate on rents and common area maintenance (CAM) charges, but one thing they will insist on is a personal guarantee.
All About Personal Guarantees
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 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 unsecured, which means you may have to put some personal asset on the line. It means you are putting personal property at risk by signing this agreement.
A personal guarantee is usually a separate document from the leasing documents. It's a contract, so it must meet all the requirements to be valid (enforceable in a court).
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. 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.
You might also try to limit the personal guarantee to only the tenant improvement costs. TI costs are a big expense 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.
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 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 gurantee removed.
If you have the financial resources, you can also offer to put a line of credit in place for a set dollar amount, and the letter can be tapped if you can't pay your lease costs in one or more months.
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.
In a dispute between tenant and landlord, a court might limit the amount of personal guarantee. For example, 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 up front, saying you'll agree to guarantee to a limited term 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 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 or a good credit rating.
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.