Ask any small- or medium-sized business owner what is one of the biggest challenges they face, and you are likely to hear that getting access to financing is difficult – especially in this economy. But what surprises many small- or medium-sized business owners is the equipment lessor or lender requires in many cases a personal guarantee in order to approve financing a business lease. The general rule is that any holder of 20% or more of the equity of a business must personally guarantee the lease and loan obligations of the business. Here are seven key things you need to understand about a personal guarantee for leasing and lending purposes. In a later post, we’ll discuss the usual exceptions and guidelines for personal guarantees.
- What is a personal guarantee? A personal guarantee is an unsecured written promise from a business owner and or business executive guaranteeing payment on an equipment lease or loan in the event the business does not pay or is no longer able to make payments under the lease. Since it is unsecured, a personal guarantee is not tied to a specific asset. However, in the event of non-payment, with a personal guarantee in place, a lender can go after the guarantor’s personal assets.
- Why do lessors and lenders require a personal guarantee? Many lenders want a small- or medium-sized business owner or executive to sign a personal guarantee as an “added assurance” that the owner or executive is committed to the business and is committed to repaying the equipment lease or loan. A personal guarantee demonstrates to a lessor or lender that you are a responsible business owner and intend on repaying all of your business leases. Furthermore, in most cases a small- or medium-sized business owners’ personal finances are comingled with the business, so it is reasonable that a lessor or lender would want this assurance. In addition, from the lessor or lender’s viewpoint, if the owner isn’t willing to stand behind the business, then why should the lessor or lender take risk?
- Why is the spouse required to sign in some cases? For the same reason a business owner is. Since in most cases a small- or medium-sized business owners’ personal finances are comingled with the business, so is the spouse’s finances.
- Are all small- or medium-sized business required to sign a personal guarantee? No, not all – it depends. The majority of lessors and lenders do require personal guarantees, and each may have slightly different guidelines. Some may be willing to fore-go the personal guarantee if the business finances are strong enough and it is well established, or if the business is structured as an ESOP or is a public company. There are many exceptions since all businesses are different. We’ll discuss the guidelines for waiving the personal guarantee requirement in a later post. A good rule of thumb, though, is that if your primary bank requires a personal guarantee for a 12 month revolving loan, then a lessor or lender providing a 3 to 5 year term lease or loan (involving more risk because of the longer term) will certainly require it as well.
- When should you not sign a personal guarantee? Be careful about signing a personal guarantee if you are not part of the executive management team and do not really have a full view of the company’s plans or finances. If you are unsure, consider having your lawyer review the document.
- What does a personal guarantee include? The personal guarantee will declare that you are personally liable for the lease or loan obligations of your business and may also declare that you are liable for default interest, legal and other fees.
- What if you sell the business? In the event you sell your interest in a business, you need to make sure you get your personal guarantee released. If you are not properly released from the personal guarantee you will still be held liable if the lease or loan goes into default. You may be required to pay off the lease as part of the sale of the business.
Please contact us if you have any questions.