A personal guarantee is a legal mechanism to make one person personally liable for a debt that otherwise isn’t theirs. For example, when I was in college, my first landlord asked for a parent to personally guarantee the lease. Generally people ask for these when the original debtor doesn’t have as strong of credit.
In business, you see them used slightly differently.
Who Wants a Personal Guarantee?
To fully understand personal guarantees, it’s best to know who would even ask you to sign this. Primarily you get two creditors asking for a personal guarantee: banks and landlords. They’re the main sources because you see very large debts with them. And, these creditors really want to protect themselves from you not paying up.
If you’re taking a loan from a bank, chances are your business doesn’t have the cash to pay it back. Without a good history or some sort of collateral, the bank will need extra security.
Landlords are similarly situated. Most commercial leases are 3-5 years. Even a low monthly rent like $1000 ends up $36,000-$60,000. That’s a huge amount, especially if you’re a smaller or newer business.
Limited Liability
Next, we have to address the concept of limited liability. By default, contractual liability between an LLC or corporation and a creditor ends at the company. Under these contracts, you personally wouldn’t be liable if the company is unable to pay its debts. There are some exceptions to this rule like fraud, but LLCs and corporations generally do their job and protect their owners.
For example, if your company takes out a $100,000 loan from you bank, your company is responsible for paying it back. If your company subsequently spends all of that money on a lavish party for your clients and immediately fails, the bank is out of luck.
What Does a Personal Guarantee Do?
Consequently, banks ask for a personal guarantee (from someone who has better financials). Now, it’s also important to note you don’t always need a personal guarantee. You will only be asked for one if the creditor feels it needs more security. That’s what they do. Personal guarantees are simply an extra way creditors get paid back.
Therefore, if you borrow $100,000 from the bank, they might ask you to sign a personal guarantee. However, they’re not going to ask you if you’re not already credit worthy enough to take out a $100,000 loan on your own. Every bank has their own metric for figuring out how to secure their loans. If you own a house with over the loan amount in exposed equity, you’ll likely be a good candidate for them.
Alternatives to a Personal Guarantee
If you don’t want to sign a personal guarantee, or you’re not a good candidate, there are some alternatives. Additionally, if you have me as your attorney, you’ve been told to find any way to not sign these. The make the limited liability portion of your limited liability protection irrelevant for this particular debt.
Instead of risking your personal assets, you can offer a larger security deposit with landlords or provide some sort of collateral. Their goal is to protect themselves, so if you can demonstrate they’d be made whole no matter what, they should be satisfied. Unfortunately, many banks and landlords are handcuffed by their internal policies. It’s worth asking, and it’s worth shopping around if they can’t cater to your request.
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