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The Dangers of Signing a Personal Guarantee for Start-up Businesses

By November 20, 2019August 5th, 2021No Comments

We get it- entering into a business relationship with a start-up business can be risky. So it’s only natural that those offering capital, commercial space, or other goods and services to a new business want assurances that they will be covered if the business has trouble meeting its financial obligations.

So, if you are a new business owner, don’t be surprised if you are asked to sign personal guarantees to secure these debts. When presented with a personal guarantee, you should take the time to read it carefully to ensure that your liability as a guarantor is limited as much as possible.  Otherwise, the protections you set up when forming your business may not shelter you from significant personal exposure down the road.

Illustration of a person walking on a tightrope outside towards money in business attire

Tips to Protect Yourself

Fortunately, guarantee agreements, like many other contracts, are often negotiable. Though you may not be able to eliminate the guarantee altogether, you may be able to limit its scope.

First, determine what triggers your obligations under the guarantee. For example, look at the number of notices of default required, who is required to be notified and given the opportunity to cure, and whether the amount of the company’s working capital is considered. Ensure that you will be given adequate notice and the right to cure, the capital thresholds are reasonable, and that your guarantee obligations do not contain an acceleration provision (meaning the full amount of the loan, rent, or other obligations will not immediately become due and payable).

If you are not the sole owner of the business, see if the obligations of the guarantee can be divided equally among the guarantors, so you will not be solely responsible for securing the debt. To that end, avoid “joint and several” language if possible and ask for indemnification language as well.

You should also ask to be relieved of the personal guarantee if your share in the business has been sold or assigned. Many fall into the trap of believing that selling their business automatically relieves them from liability under the guarantee. Remember, though, unless there is express language in the guarantee agreement, or a subsequent agreement between the parties relieving you of such obligations, you may remain a guarantor despite selling or assigning your business.

Do not enter into an unlimited guarantee. Instead, see if the loan or rental obligation can be limited either to a specific dollar amount or by a percent of the outstanding loan. You can also offer other collateral in exchange for eliminating or limiting the guarantee.

You can also request the personal guarantee be reduced when the company becomes more established or once a certain number of timely payments are made. This will help limit your personal exposure over time.

See if there is anything you can do to avoid or limit the personal guarantee. Some banks and companies will offer higher interest rates or higher initial balance payments in exchange for eliminating or limiting the guarantee. Just be cautious about over-extending yourself too soon.

For commercial lease guarantees and other sale of goods/services transactions, you should insist that the landlord or provider be required to mitigate its losses. This will limit the overall exposure of the liability. You can also request that the dollar amount be capped at a certain amount.

Make sure that you do not include your spouse as a guarantor. By doing this, joint assets will be better protected, and typically, assets solely in your spouse’s name will not be accessible to the creditor. Relatedly, you should try to carve out certain assets, such as your personal residence, from the scope of the guarantee.

Lastly, you can look into personal guarantee insurance to protect your personal assets and limit personal risk.

In sum, because so much is at risk when guaranteeing a loan or other significant obligation, it is strongly advised that you allow your attorney to review the language and assist with negotiating the strongest protection for you. Though no one wants to believe their new business will default on its monetary obligations, it is certainly better to prepare for it ahead of time rather than trying to limit your exposure after-the-fact.

Cindy Menta is an Associate Attorney attorney at Gertsburg Licata. Her practice is focused primarily on real estate transactions and commercial litigation. She can be reached at [email protected]

Gertsburg Licata is a full-service, strategic growth advisory firm focusing on business transactions and litigation, M&A and executive talent solutions for start-up and middle-market enterprises. It is also the home of CoverMySix®, a unique, anti-litigation audit developed specifically for growing and middle-market companies.

This article is for informational purposes only. It is merely intended to provide a very general overview of a certain area of the law. Nothing in this article is intended to create an attorney-client relationship or provide legal advice. You should not rely on anything in this article without first consulting with an attorney licensed to practice in your jurisdiction. If you have specific questions about your matter, please contact an attorney licensed to practice in your jurisdiction.

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