A personal guarantee is when a person promises to cover the debts of another. For example, you can personally guarantee your business’s lease. In that example, you’re promising to pay the rent if the business ever misses a payment.
They have their place, but it’s important to know what you’re signing before you get yourself into a bad situation.
Personal Life Guarantee
If you’re anything like me, your first encounter with a personal guarantee was a lease or car loan. In those cases, I was young with incomplete credit. Therefore, I needed a parent or someone with good credit to personally guarantee my debts. Because of my age, I didn’t have a long enough history of good payments for a bank or landlord to trust my ability to pay. The guarantee just gives them some added protection on their end.
Business Guarantees
Business if often the same way except that business credit is handled differently. Instead of looking at a credit score, a bank will look at your accounting records, tax filings, court cases, and anything else that is public record to see if your business is a reliable customer. Again, age has a lot to do with it. New businesses almost always need guarantors.
There are a lot of other areas where a personal guarantee makes sense in the business realm. For example, I regularly work these into company purchases. If any money is being paid over time, I want my seller clients protected as best I can.
In the case where one company is buying another, the purchasing company is on the hook for the full purchase price. However, what happens if that purchasing company files for bankruptcy or dissolves before they’ve paid the full price? Without a personal guarantee, the seller loses some of the money the seller was owed.
That’s why personal guarantees, collateral, and other protective terms are important in these transactions.
Circumvents Limited Liability of LLCs/Corporations
On the other hand, if you’re asked to personally guarantee the debts of your business, you should be very careful. Normally, LLCs and Corporations create a limited liability shield for their owners. However, you let creditors passed the shield if you personally guarantee those debts.
Obviously, the best plan is to pay all your debts, but sometimes things happen. For example, a lot of people had to shut down their businesses due to a worldwide pandemic. Were the landlords forgiving? Most were not very understanding at all.
There are some things you can do to avoid providing a personal guarantee. For example, when Law++ was getting their office, the landlord asked for me to be the guarantor. Instead, I negotiated that away by offering a higher security deposit. Remember, the goal is to provide security for the creditor.
Example
I recently had a client who was selling their business. In their case, they were selling directly to an individual with payments over three years. In that case, having the buyer personally guarantee the purchase price wouldn’t help because the buyer was already an individual on the contract.
Extreme Cases
In bigger business sales, I’ve had to have the buyer and the buyer’s spouse personally guarantee the purchase price. In those cases, we wanted access to any joint property (like a house) in case the buyer didn’t pay what was owed.
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