The experienced business owner is no stranger to signing personal guarantees. It has become standard practice for lenders to require owners, and even their families, to sign a personal guarantee (PG) to secure a commercial loan.
While this is often the price of doing business, what does a personal guarantee mean to business owners, partners and even family members? What, if anything, can be done about them?
While they are nothing new, PGs have become commonplace as tight credit conditions have forced banks to become increasingly conservative in their lending practices.
A PG is a note signed by a business owner, partner, investor or family member – also known as a loan guarantor –– that puts up personal assets in addition to business assets as loan collateral. If the loan defaults, the bank can then go after things like homes, bank accounts and investments – and they don’t even have to wait until the business assets have been liquidated to address the outstanding debt.
As a PG being called can have grave consequences, small business owners owe it to themselves to develop a PG negotiating strategy before sitting down in front of a loan officer. The following five steps are a practical guide for walking through the negotiating process in order to get the best deal possible while lessening the risk of losing hard-won personal assets.
How To Negotiate a Personal Guarantee
1. You Need to Know What You’re Signing
There can be a wide variance in the terms of a PG. For instance, they may permit the bank to go after personal assets even if there isn’t an outright loan default. Triggers can include a technical default, additional borrowings, sale of assets, death or incapacitation.
Other times, the PG can allow the pursuit of additional collateral on demand if the lender believes the loan is under-secured. While many business owners mistakenly believe incorporation acts as legal protection that prevents a lender from pursuing personal assets, this is not the case when a PG is in force.
2. Know Who You Are Signing With
In partnership scenarios, each person usually signs a “joint and several” PG agreement. You might think that this spreads the risk out evenly among the partners, but that is not the case.
In fact, the lender is free to pursue whichever partners it wants and those with the most liquid assets are usually the most vulnerable. As a result, a partner can find himself in the difficult position of pursuing relief from other partners – who are often friends or family members – on his own.
3. Determine an Acceptable Level of Risk
As a business owner or partner, you need to determine your own acceptable risk threshold, both on a business and personal level, before approaching the bank. This means calculating the assets you would need to satisfy the PG. You also need to bear in mind the fact that if the business is challenged – more than likely the case if the loan is being called – its assets will be worth much less than book value.
Based on this assessment, you can calculate how much of your personal assets to risk on the loan and still sleep at night.
4. Negotiate the PG Terms
While nearly every term in the PG can be negotiated, you need to figure out which ones are most critical to you as well as which ones the lender will not likely want to change. Armed with this knowledge, you can map out your strategy for negotiating both the PG and the loan documents.
Here are a couple negotiating tactics to consider:
Limit the guarantee: Banks will always want an unconditional or unlimited guarantee, but you can ask that it be limited either in terms of actual dollars or based on a percentage of the outstanding loan. In a partnership situation, you can ask the lender to limit the amount of exposure based on the size of each partner’s owner ownership stake.
Suggest terms of relief: Ask to be relieved of the PG after a certain percent of the loan has been repaid. You could also suggest that it be reduced as a key financial metric improves, such as your debt-to-equity ratio. Another option could be to ask that the amount or percentage of the PG be decreased after five years of issue-free loan payments.
5. Keep the Door Open to Future PG Negotiations
Even after the PG is signed, you can always approach the bank to reopen negotiations of loan and guarantee terms based on changes in your situation such as improved financial performance or increased collateral. Having personal guarantee insurance can also allow you to seek loan/PG concessions.
While it may not be possible to completely avoid a PG, given credit conditions in the current economic climate, business owners and their partners do have options.
Take advantage of good counsel from advisers like your attorney or accountant and develop a carefully planned approach for negotiating the terms of your PG and loan.
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