Small Business Loans: How to Handle Personal Guarantee Negotiations

Signing a personal guarantee has become standard practice in the commercial loan approval process, but what does a personal guarantee (PG) really mean for you and your business?

For small business owners, signing a personal guarantee has become standard practice in the commercial loan approval process. While this is often the price of doing business, what does a personal guarantee (PG) really mean?

The proceeds of commercial loans may be used to fund large capital expenditures and operations that your small business may otherwise be unable to afford. Moreover, when applying for a business loan, a personal guarantee (PG) gives the bank permission to go after personal assets should your business default on the loan.

In addition to letting lenders pursue personal assets, many allow the PG to be called for things like technical default, additional borrowings, a sale of assets, death, or incapacitation. Some even allow the lender to obtain additional collateral on demand if the lender determines the loan to be undersecured.

In the case of a partnership, the most common form is a “joint and several” guarantee. This means the lender doesn’t have to pursue the personal assets of each partner equally, but is free to pursue those with the largest, most liquid assets. This puts some of the partners at a greater risk of loss and may require them to pursue claims against the other partners – who are often family or friends.

Contrary to popular belief, the legal benefits of incorporation will not protect business owners from a PG. By signing a PG, guarantors give the lender permission to pierce the corporate veil and gain access to savings accounts, cars, and property – including your family home.


Understanding Personal Guarantee Negotiations

As a small business owner it is important to understand not only what a PG is and does, but how you can successfully navigate the murky waters of PG negotiation.


1. How much risk can you accept?

First you should know your risk tolerance – both business and personal – before talking to a bank. This will greatly affect the amount and type of loan you should seek.

There’s the basic calculation of what would be required should the PG be called. Here’s where your accountant can add value by helping you evaluate your company’s liquidation value, taking into account any existing liens and the priority of repayment in case of bankruptcy.

Once this is done, you should consider the amount of personal assets you can risk on the business loan, including your equity in the business. What is an acceptable amount to gamble? The answer may be nothing – but whatever the number, it should be figured into the initial loan negotiation.

The basic equation should be:

Liquidation value of the business + acceptable personal risk > personal guarantee

Also be sure that your accountant considers factors beyond personal finance when they calculate your personal risk figure. For instance, if you have a spouse who will lose sleep at night or children about to enter college, the PG could dramatically affect your personal life. These issues should be discussed openly.


2. Define your terms in advance

Here are several important questions you should consider before you apply for a small business loan:

  • Would you be willing to pay a higher interest rate in exchange for no PG or a limited PG?
  • Would you consider borrowing less money?
  • Would you be willing to put up a higher compensating balance for the money borrowed, which really translates into a higher interest rate?
  • Would you consider a shorter maturity date on the loan, after accounting for the added risk of higher monthly payments?


3. Maintain control during negotiations

Once you enter the bank, keep calm and stay in control. Don’t let emotions get the better of you, and remember that everything is negotiable.

Your first step should be mentioning the PG up front. Most banks will want to first negotiate the terms of the loan and then the terms of the PG. Instead, they should bundle the conversation about the personal guarantee with the discussion of other key loan terms, such as amount, term, interest rate, and covenants.

Next, ask the loan officer why the bank wants a PG. Once you understand their specific concerns, you will be in a better position to address them directly, rather than through a blanket guarantee.

You can also ask how big a business needs to be to avoid a PG at that particular bank. While many banks require PGs as a general policy to make sure that the owner is tied to the business, knowing as much as possible about specific concerns will help you better understand your ability to negotiate.


How to Negotiate the Terms of a Personal Guarantee

Here are five negotiation tactics to utilize when you are ready to negotiate the terms of your personal guarantee:


1. Limit the guarantee

Banks will always want an unconditional or unlimited guarantee. Start by requesting that the amount of the PG be limited either by an actual dollar amount or by a percent of the outstanding loan. For example, if your business has a $1 million line of credit, you can seek to limit exposure to 20 percent of the outstanding balance. If there are multiple owners, you can also seek to limit the amount of exposure by the percent ownership for each partner.


2. Suggest terms of relief

As a borrower you can ask to be relieved of the PG after a certain percent of the loan has been repaid.


3. Modify reporting requirements

Lenders typically require guarantors to submit personal financial information at least annually. Generally, as the borrower you should avoid filling out the standard boilerplate personal financial information for a commercial loan. This is a road map for the bank to find and request personal assets. As an alternative, you can work with your accountant to draft a personal financial statement with the minimum acceptable disclosure.


4. Decrease PG with improved business performance

Your can suggest the PG be reduced as a key financial metric improves, such as your debt-to-equity ratio.


5. Structure when the PG would go into effect

This could be based on the number of loan payments missed, the amount of working capital of the business, or the net worth of the business falling below a specified amount. Also, consider requesting business days vs. actual days to give them more time for reporting and the ability to respond to changing circumstances.


6. Ask that the PG terms will change over time

For example, the amount or percent could decrease after five years of spotless payments.

As a small business owner you need to know what’s important to you. Evaluate the above strategies in the context of your particular business, the loan, your relationship with the lender, and your options for alternative sources of financing. Ultimately, it is important to consider which modifications will provide the most value and negotiate the loan terms, conditions, and the guarantee agreement as a package.


This guest post, which originally appears in AccountingWEB, is contributed by James R. Coughlin, the chief underwriting officer for Asterisk Financial Inc. In it, Coughlin discusses how to advise business owners about personal guarantees and what choices they have. A personal guarantee is almost impossible to get around when signing a commercial loan, but there are a few things small business owners can do before signing. Read more at AccountingWEB. Connect with Sageworks on Twitter.


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