A mistake that new businesses or entrepreneurs occasionally make is agreeing to personal guarantee clauses within their contracts without fully and carefully considering the risks. Remember, by forming an LLC or corporation you have a strong, statutory protection against creditors attacking your personal assets, BUT, if you sign up for a personal guarantee, you may just be forfeiting those rights.
Be Wary of Personal Guarantees
by Richard Reinis for Bloomberg Businessweek
As a veteran attorney, I’ve helped many clients avoid the risks of signing a personal guarantee. However, when it came to protecting myself in order to get financing as a Krispy Kreme franchisee, I didn’t heed my own advice.
It’s a mistake I’ll never forget. Signing a personal guarantee gives your creditors the right to pursue personal assets if your company defaults—even before the business assets are liquidated. As this was not news to me, why did I sign, knowing the pitfalls? Because I wanted the business deal and thought I couldn’t get it without signing. I thought the risks were not that great.
Here’s what the lenders told me: “A personal guarantee is no big deal; it’s just a requirement of bank examiners;” “we never sue unless we think we’re being deceived or defrauded;” and “everybody signs it—it’s nothing to lose sleep over.”
[However,] when my personal guarantee was called, I paid dearly in sleepless nights, guilt, and shame. I don’t know how many years of my life this emotional strain cost me, but I know how many years I’ll have to work to make up the loss. In order to avoid this nightmarish scenario, here is how you can protect your assets—and your sanity:
1. Tell your family the truth about the personal guarantee, upfront. You can’t put your home and bank accounts on the hook without telling your spouse.You’d be amazed how few businessmen tell their wives when they do this.
2. If possible, don’t guarantee an obligation for a business you don’t own outright. If your stake is just 25 percent, you might think you’re O.K., but they can still go after you for the whole indebtedness. So unless you own the business outright, think carefully about obligating yourself. Ask the lender if you can limit the personal guarantee to your share. Have a written agreement with the company and your partners that no matter who gets sued on the personal guarantee, the others will pay their share.
3. Try to make the agreement better for you. There are many ways to modify a personal guarantee, but it’s harder to do in this credit environment. Nevertheless, you must ask. You might even get the bank to agree that the personal guarantee won’t be enforced unless there’s been a fraud. As I tell people, you can walk into the bank and say: “I love my wife more than my banker, so carve out the house—or I’ll find someone who will.”
4. Get insurance for your personal guarantee. Don’t wait on this one: By the time the guarantee is called, the game is over. Your equity may be wiped out, your business may be in default, and you haven’t protected yourself. Personal guarantee insurance is available now, though it wasn’t when I signed my personal guarantee. It would have given me the bargaining leverage and peace of mind I sorely needed.
Take it from someone who learned the hard way.
The Law Office of Brandon Woodward P.A. is pleased you have visited our web site or read our blog. The materials and information contained here are provided for informational purposes only and are not to be considered as legal advice. For questions about personal guarantees, contract clauses, or any other legal issues facing your business, contact Brandon Woodward, Attorney at Law, directly at firstname.lastname@example.org for a FREE consultation.