THINK TWICE BEFORE SIGNING THAT PERSONAL GUARANTEE

By Scott A. Marquis, Esq.

If you own your own small business, executing personal guarantees may seem like a fact of life because guarantees are so popular with lenders. Moreover, personal guarantees are often sprung upon the business owners almost as an afterthought by lenders, many of whom act as though there is simply no other alternative. Because personal guarantees are often short, innocuous looking documents, they may not trigger red flags for most business owners. However, you should always think twice before signing a personal guarantee, and it often is beneficial to investigate other financing options.

Initially, business owners should realize that there are generally options available that do not involve a personal guarantee. Lenders might charge a higher interest rate and higher fees in order to provide a loan without a personal guarantee, but the higher costs are often worth the financial security gained. While lenders will generally ask for a personal guarantee, you can usually find a lender who is willing to make the loan your business needs without requiring a personal guarantee.

Before you dismiss the possibility of obtaining a loan without a personal guarantee due to the high cost, you should carefully weigh that additional cost against the potential ramifications that could occur if your business is unable to pay the debt for one reason or another. In fact, the ramifications can be so severe (read that as “costly”), they make the additional cost of a loan without a personal guarantee seem miniscule.

Due to the recent slump in the housing market, there are many who are suffering financial hardship. Consider, for example, the difference between two companies involved in the residential development business.

Company A, a small home developer paid substantially higher loan fees and interest in order to avoid personal guarantees by the owner of tens of millions of dollars in loans. The owner of Company B, on the other hand, personally guaranteed substantial sums that he borrowed to purchase land intended for residential development. Due to the poor housing market, Company A essentially folded up shop and transferred his company’s properties back to the lenders. Although the lenders have not been pleased by this turn of events, the owner of Company A’s personal financial situation remained secure. Thus, even if his business is eventually forced to file bankruptcy due to the poor housing market, the owner of Company A is still financially secure due to his refusal to execute personal guarantees on his company’s debts.
On the other hand the owner of Company B personally guaranteed a loan for over $10 million to purchase a piece of property upon which he planed to develop residential homes. Although Company B was successful in obtaining all necessary approvals and permits from the applicable government agencies, Company B was subsequently unable to obtain a construction loan for the development of the property. After more than a year of holding the property, Company B’s development partnership went into default on the purchase money loans and had to file for Chapter 11 Bankruptcy.

Unfortunately, Company B’s problems didn’t stop there. After his development partnership filed bankruptcy, the lenders turned around and sued the owner and his partners personally based upon their loan guarantees. Essentially, this caused the failed business venture to become a financial disaster for Company B. Although the owner tried to negotiate with the lenders and mitigate the damages he will personally suffer, the owner is potentially faced with the prospect of paying for a deficiency judgment which could amount to several million dollars once default interest and penalties are all factored.

This is certainly not a situation any successful business person would like to find himself in after working so hard to become financially secure. It can be absolutely devastating to realize that you could lose it all because of one bad deal – and a personal guarantee.
In summary, the recent downturn in the residential housing market should be a warning to us all that none of our business ventures are guaranteed successes. Most of us have had businesses or investments which have been unprofitable or have failed altogether. Thus, even if times are good and your business is booming, keep in mind the potential ramifications of a personal guarantee and seriously consider paying the additional costs necessary to avoid that obligation. It could make all the difference in your own personal financial success.