In the early stages of building a company, owners needing access to capital may find themselves signing a personal guarantee on a business loan. As the company grows and acquires property and equipment, those assets and/or company cash flows may satisfy the lender's need to mitigate risk and eliminate the need for the owner to provide a personal guarantee. That's a major milestone for the owner, as he or she can now separate the company's liabilities and financial obligations from her personal assets, reducing risk for her family.
As the name implies, a personal guarantee on a business loan means that if your company defaults on the loan, the lender or creditor can go after your personal assets, including wages, real estate and other tangible property. For a start up, lenders typically want owners to personally guarantee 10 to 20 percent of the company's total equity, according to Christine Lagorio-Chafkin's Inc magazine article, “What You Need to Know About Making a Personal Guarantee.”
That said, the percentage you must personally guarantee can be negotiated, according to Lagorio-Chafkin. The Small Business Administration now requires that anyone owning 20 percent or more in the company provide a personal guarantee, and Lagorio-Chafkin notes many lenders seem to prefer multiple guarantors, as it spreads out the risk.
Although most personal guarantees are unsecured — meaning the bank has only your good-faith assurances to repay if the business defaults — some lenders may require the guarantee be secured with specific personal assets, such as your home equity. Considering a start-up business loan has the highest risk in the bank's loan portfolio, asking you to have skin in the game is reasonable.
So when does a company graduate from needing personal guarantees from the owners on its loans and lines of credit?
According to Michael Lockwood, banks typically won't require personal guarantees for well-established businesses with annual revenues of more than $25 million. The problem for some owners is the legacy personal guarantees on loans or lines of credit established during the company's growth years.
If your company is growing and able to make its loan payments, never placing the business in default, the bank will have no reason to pursue your personal assets. Over time, the bank may extend the line of credit or provide additional loans, also with your personal guarantee. In situations requiring capital for buying out minority shareholders or a major acquisition, you may find yourself hamstrung by your personal guarantees as your company's debt expanded with its growth.
Obviously, repayment is one way to release yourself from a personal guarantee on a loan for your business. You may also be able to renegotiate the loan with your bank, asking them to remove your personal guarantee based on the company's assets and performance. There's also the option of refinancing your company's debt and eliminating your personal guarantee through an institutional debt provider or a private equity firm..
Receiving and repaying business loans can have wide reaching effects on your company and your personal finances, especially if you founded the company and have kept it closely held. Finding the right combination of capital strategies requires a deep understanding of your business, your lenders and the options you have for freeing yourself from personal guarantees.
Bridgepoint Investment Banking has the experience and capital relationships to help business owners untangle even the most intertwined business and personal finance situations to enable company growth, reduce personal risk and build a solid legacy for generations to come. Contact us for a confidential, no-obligation consultation.