What Is a Personal Loan Guarantee?
Before you sign on the dotted line, take some time to understand your liability.
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Several recent questions have been directed at the concerns manybusiness owners have regarding how a personal guarantee works whendoing a funding deal. It's very important that you seek expertlegal advice about the specific laws of your city and state, asthis article simply aims to provide an overview of the basic issuesrelated to a personal guarantee.
There are several details to consider, but the main line ofreasoning begins with the words "personal" and"guarantee." These words mean what they say, so beforeputting their signatures on financial documents for the company,entrepreneurs need to consider very carefully the future potentialimpact these two words could have. The main concern? Liability forthe obligation agreed to by the firm.
The first word, "personal," refers to you, theindividual, the owner of the company. It doesn't refer to yourboard members, your senior managers or any of your employees. Itdoes not allude to the tax professional or attorney who providesbusiness advice. In the case of a proprietorship, theowner/entrepreneur and the business are one and the same in theeyes of the law. When Mary Owner signs for Mary Owner Services, theline between personal and business is obviously not there. But evenin the case of a dba, an LLC or a corporation, the line can also bevery hard to find because it's not the company's name onthe signature line-it's your name out there all byitself.
The second word, "guarantee," means "a pledge orassurance." Therefore, the term "personal guarantee"translates to you providing your own individual pledge or assurancefor an obligation. Depending on the exact wording of your financingdocuments, you are personally pledging that you will make good onthe obligation, even if your form of business organization provideslimited liability protection under the law.
Businesses can be set up under different legal forms. Some ofthese provide limited liability inherent in the structure toprotect and separate personal assets from those of the company.Others, however, expose owners to unlimited liability, wherepersonal assets are unprotected from claims made against thecompany.
For example, when Mary Owner operates her services company asBig-Time Benefits (the dba for Mary Owner), there is no liabilityprotection inherent in the company's organizational structure.(A dba is essentially a proprietorship with a different operatingname than the owner's name.) So even though the dba appears oncertain contractual documents, that business is still one and thesame with Mary Owner.
In the case of the partnership Big Time Benefits LP, Mary andher partners (including general partners, who participate in thedaily management of the firm, and limited partners, who are simplypassive investors without any managerial oversight) may operate thefirm under that company name, but she and the general partners arestill one and the same with the business. The limited partners dohave specific legal protection from liability, but consult yourattorney about the specific laws in your city and state.
In the case of a corporation (depending on the form chosen andthe state in which incorporation is originated), the shareholdersare the owners of the company Big Time Benefits Inc., but the firmitself is recognized as an independent, tax-paying entity undermost laws. Mary Owner may be a majority shareholder in the company,but the corporate organizational structure does provide a level oflimited liability protection for her and the other shareholders.Typically, the firm's name is on all the legal documents,including employment agreements, financing contracts and the like.In the event of a failure to make good on a certain obligation, theliability belongs to the corporation.
Sometimes, however, a newly launched firm may be required tohave a personal guarantee on certain loans, credit cards or otherdebt obligations. The general rule of thumb is that even though thecorporation provides liability protection to shareholders, anyindividual who provides a personal guarantee-even if thatperson is a shareholder-has contractually agreed to make goodon the obligation in the event the corporation cannot. Because thepersonal guarantee is like a co-signer on a loan, the creditor willcome to this person once it's determined that the primaryborrower cannot meet the financial obligation. This could pertainto an equipment lease, a partnership agreement with a person oranother firm, a real estate lease with a landlord, or various typesof loans.
Providing the personal guarantee is generally viewed as aseparate issue from whether or not the individual has limitedliability within the company's organizational structure. Thebest approach is to make sure any company obligations are truly thecompany's concern alone and that your individual name is notincluded in the documentation. So when a personal guarantee ismade, be prepared to cover that obligation in the event thebusiness cannot.
David Newton is a professor of entrepreneurial finance andhead of the entrepreneurship program, which he founded in 1990, atWestmont College in Santa Barbara, California. The author of fourbooks on both entrepreneurship and finance investments, David wasformerly a contributing editor on growth capital for IndustryWeek Growing Companies magazine and has contributed to suchpublications as Entrepreneur, Your Money,Success, Red Herring, Business Week, Inc.and Solutions. He's also consulted to nearly 100emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are thoseof the author, not of Entrepreneur.com. All answers are intended tobe general in nature, without regard to specific geographical areasor circumstances, and should only be relied upon after consultingan appropriate expert, such as an attorney oraccountant.