6 Ways To Protect Your Assets From A Personal Guarantee
A lot of companies need a business loan to get started or to expand. Ideally, a business would borrow on its own, but in today’s lending environment that’s not always an option. Many business owners and executives may be asked to provide a personal guarantee of the loan, either in full or part. Without a personal guarantee, a significant number of businesses simply can’t get loans. In exchange for no personal guarantee or a limited personal guarantee, a borrower may be required to accept a higher interest rate, larger down payment, shorter term, or less money.
A personal guarantee is an unsecured written promise from a business owner and/or executive guaranteeing payment on a loan in the event the business does not pay. A personal guarantee is not tied to a specific asset. In the event of non-payment, a lender can seek to acquire any of the guarantor’s personal assets. Personal guarantees can also be pursued in other circumstances, including technical default, additional borrowings, a sale of assets, death or incapacitation. In some situations, the lender is allowed to obtain additional collateral on demand if the lender determines the loan to be under-secured.
Contrary to popular belief, the legal benefits of incorporation will not protect business owners and executives from a personal guarantee. By signing a personal guarantee, the borrower gives the lender permission to pierce the corporate veil and gain access to individual assets. Many lenders require a personal guarantee as an added security that the owner or executive is committed to the business and is committed to repaying the loan. The general rule is that any holder of 20% or more of the equity of a business must personally guarantee the loan obligations of the business.
Individuals should be careful about signing a personal guarantee if they are not part of the executive management team and do not have a full view of the company’s plans or finances. Prior to speaking with a lender, business owners and executives should determine what they can reasonably afford to risk. Below are six strategies that can protect your assets from a personal guarantee.
Limit the guarantee
Most banks will want an unconditional or unlimited guarantee. The first step is to request that the amount of the personal guarantee be limited either by the actual dollar amount or by a percent of the outstanding loan. Multiple owners should seek to limit their amount of exposure to the specific percent of ownership for each partner.
Modify financial reporting obligations
Lenders typically require guarantors to submit personal financial information. In many cases, a business owner or executive should avoid filling out the standard personal financial information for a loan. As an alternative, borrowers can draft their own personal financial statements with the minimum acceptable disclosure.
Decrease guarantee over time or with improved business performance
A guarantor may seek the reduction of the personal guarantee after a certain period of time, after a percent of the loan has been repaid, or as a key financial metric improves.
Request specific carve-outs
A guarantor should seek to eliminate a primary residence or stock in the business as an asset tied to the personal guarantee.
Remove spousal guarantee
If possible, a guarantor should avoid having their spouse as a cosigner on the personal guarantee. This provides spouses with some protection because personal assets under the spouse’s name will not be included should the personal guarantee be called.
Obtain personal guarantee insurance
Recently, personal guarantee insurance (PGI) has become available to protect the personal assets of business owners and executives. This insurance can limit personal risk to a more reasonable level. After taking into account the value of the liquidated business assets, the insured uses personal assets to satisfy the remaining obligation. PGI will cover up to 70% of the insured’s net liability, depending on the coverage purchased and the terms of the policy.
It may be impossible to completely escape a personal guarantee or to obtain every concession. However, a personal guarantee should be assessed on a continual basis. Many factors, such as business revenue, personal and business credit, length of existence, business industry, local market, and the relationship with the lender will impact which terms, conditions, and limitations are approved.