What Does it Mean to Be a Personal Guarantor?
Across the board financial institutions have tightened their reins on lending. As a result, business owners are expected to become personal guarantors for whole or partial loan amounts that they would like to take up. In fact, this has become a business norm. A personal guarantee has become a necessary evil to business owners. Becoming personal guarantors adds to the risks that a business owner assumes. But without which a business owner may be unable to fund a business expansion plan or buy inventory required to stay in business.
Business owners often become personal guarantors thinking they can repay the loan. But business owners do make miscalculated business moves or have misplaced optimism in their ability to repay a loan. They would then find themselves in an unfavourable position when they are unable to serve their financial commitment to banks or even suppliers.
So what is at risk by becoming a personal guarantee?
Pitfalls of personal guarantees
In this context, a personal guarantor is responsible for repaying business debts should the business dissolve or default on a loan. He or she will have to secure loans by pledging personal assets in addition to business assets as loan collaterals. It could be assets of tangible financial value such as a business owner’s house, car, bank accounts or savings. Essentially, signing a personal guarantee places one’s finances on the line. It means that banks or creditors can go after one’s personal assets to fulfil the loan obligation.
Business debts become personal debts
You become personally liable when you sign a personal guarantee, regardless of your company structure. Take the example of a general business partnership. If each partner holds at least 20% of the business, banks could require a several guarantee or joint and several guarantee. In a several guarantee, each partner is liable for the percentage of loan equitable to his or her stake in the business. In a joint and several guarantee, banks can go after one partner if another fails to repay his or her agreed loan amount or percentage. As you imagine, banks usually require a joint and several guarantee to safeguard their interests.
This means that each partner or guarantor has guaranteed the entire loan balance. In the event a guarantor dies or declares bankruptcy, joint guarantors will be fully liable for the entire debt balance. This means that banks possess the legal right to pursue you for your joint guarantor’s share of a loan.
Consider the hypothetical case of Harry and David Company. Harry owns 70% of the business and David owns 30% of the business. Both partners signed a joint and several guarantee for a business loan of $300,000. When the business failed,
banks pursued David for a greater portion of the loan because his assets were more liquid. This is in spite of the fact that Harry owns majority stake in the business.
This applies to business owners who have set up a separate legal entity. Even though structures such as a corporation, limited liability company (LLC) or limited partnership offer protection against legal liabilities, personal guarantee obligations are still binding. Becoming a personal guarantee for a business loan instantly blurs the line between your personal and business assets. You are now personally liable for your business debts.
Mitigate personal losses as a personal guarantor
Many business owners become personal guarantors to secure loans for business needs in spite of its implied risks. But this can have dire implications on their personal assets. It invariably exposes them to the real threat of losing their homes and savings should the business fail. Becoming a personal guarantor can
compromise your financial position and rock the financial well-being of your family members. This is why seeking legal advice is important.
It is also important to protect your personal assets from personal guarantor liabilities. You can do this through wealth management tools such as debt cancellation insurances or asset protection trusts. Here, debt cancellation insurances ensure that debts do not get transferred to your family members. Asset protection trust, on the other hand, keep your personal assets from creditors’ claims from the start. The result is better financial security for you and your family.