If you get a loan from a bank or private lender for your business, you will probably be asked to sign a personal guarantee that puts your own assets — such as real estate, savings, or other valuables — on the line should your business be unable to pay the bank back. Many business owners are so relieved to get the loan that they don’t read the fine print that puts them at risk. You should. And, you should attempt to negotiate.
To be sure, not every entrepreneur will be successful in negotiating the terms of the personal guarantee, especially if you’re just starting a business. “Those that will be most successful will be those who have three to five years experience and have survived this most recent [credit] crisis,” says Jim Coughlin, the chief underwriting officer for Asterisk Financial, a personal guarantee insurance company headquartered in Middletown, Conn. “The lender clearly is in the driver’s seat almost always — especially in this credit market — because they have the cash that the small business owner wants or needs.”
But there are ways you can protect yourself, especially if you negotiate with several lenders at once. Here are four things to consider.
1. Spread the risk. Sometimes, all owners of a business, not just the primary owner, will have to sign the bank’s personal guarantee. For example, if you have multiple investors that own 10 percent of the business, they might each have to sign the personal guarantee. While every investor in the business should carry some of the risk, it is not fair for a 10 percent owner to be on the line for 100 percent of the debt, says Coughlin. You should try to negotiate to have your 10 percent investor responsible for only 10 percent of the debt.
Also, it is always best to avoid having your spouse sign the personal guarantee, if possible. That way you protect the assets that are not owned jointly, says Coughlin.
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2. Shorten the timeframe. Although many personal guarantees are signed “unconditionally and forever” for the term of the loan, you should try to negotiate an end date. For example, request that the terms of the personal guarantee only apply to a portion of the time frame you are given to pay back the loan. You can also negotiate an end-date on certain provisions of the personal guarantee, says Coughlin. For example, you can ask that if you make payments on time each month, a certain portion of the personal guarantee will “sunset.”
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3. Limit the amount to guarantee. Another way to protect yourself is to request that only a portion or percentage of the loan be covered by the personal guarantee, says Coughlin. For example, if you are borrowing $1 million, you can ask to have your personal guarantee cover 60 percent of the loan, or up to $600,000. That way, if your business is unable to pay the loan back, then your personal assets and collateral are not on the hook for the full $1 million. Rather, in this example, you would have to pay $600,000 to settle the debt.
4. Beware of risking it all. Carve out certain assets from what the bank can seize, like the home you live in, if you default on the loan. Certain states — like Florida and Texas — have it written into the law that banks can’t seize your homestead. If, however, you live in a state where this is not protected, then you should be sure to write that provision into your personal guarantee.
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What is your best tip for negotiating your personal guarantee on a bank loan? Leave a comment and let us know.