Guaranteeing Your Company’s Debt- Why Do Banks Care and Why its Not Such a Big Deal

I’ve seen so many owners that will do anything to get out of guaranteeing their own company’s debts. While the owner believes that his or her company should stand on its own, and that not guaranteeing debt is a point of pride for them, I believe they often don’t understand the reason why the bank’s are asking them to guaranty. To the bank, the guaranty stands as their surety that the owner of the company is taking its debt and the repayment of it as seriously as they would their own personal debt. Bankers like to say that the guaranty is the representation of the owner’s “skin in the game” just like if we asked them to put in a certain percentage of personal equity if they were buying a house (or for example, if they buy their first company instead of starting a brand new one.) It is one way that the bank can reassure itself that they will work as hard as they can to repay that loan.

My experience with how guarantees work in the real world is very different from what you would expect of a guaranty. Several years ago, I spent some time in a bank working out some loans from a prior lender that taught me why we shouldn’t lend money to every nice person that says they are going to start a company. The borrowers were very nice people who had started companies with every intention of success. Unfortunately, the reality was that they were not successful for a number of reasons. They ended up in business and personal bankruptcy and I was required to work through it with them.

What I found is that by the time the bank has figured out that the company is going under, the personal guaranty is only somewhat or not at all useful in helping to acquire personal assets to pay off the debt. At that point the owner has generally used all of their resources to keep the company going and there is very little of value to take- the house is generally encumbered enough that the amount remaining is less than maximum home equity the owner is allowed to keep in a bankruptcy proceeding. The guarantee itself does not allow the bank to just walk in and take your stuff- it only allows the bank to sue you to try and claim it, unless it is backed up with actual liens on property. Often the stuff the owner has left isn’t worth the cost of the legal representation to get- especially at liquidation prices. Out of the three I worked on the guarantees were worth nothing, although one of my coworkers did get to repossess a 40 foot motor home, and it had been fairly well trashed by the time he got it.

The reality is that business owners should get used to signing personal guarantees for their companies. My most recent poll of the Puget Sound banks on guarantees showed that 100% of them required guarantees for all companies unless they were over $50 million or so in revenue- at that point some of them would negotiate. The majority of respondents were adamant that unless the company had a multitude of owners with none over 20% or it was a publicly traded company, that all owners with 20% or more ownership would sign personal guarantees. Period.
In order to facilitate this when you are shopping for a new bank, be prepared to hand over the last three years of tax returns, INCLUDING any K-1s, along with a signed personal financial statement. The SBA has a great PFS form at http://www.sba.gov/content/personal-financial-statement that is usable with any bank.

To sum up, guarantees are inevitable, personal financial information required, and unless you are very wealthy are not likely to be any worse for you than having your company go under as you’ve probably spent all your money trying to keep it afloat already. Unless you have significant assets, the bank will often forgo suing because they are likely to spend more than they would get. So consider that piece of paper merely the bank’s way of confirming that you are as interested in paying them back as they are and spend more time arguing about your fees and covenants- after all if you’re a good sport about the guaranty the least they can do is decrease your rate by a half point, right? Right!

Follow Us!



Testimonials

There's a reason Michelle has so many recommendations and that they are so sincerely penned: she's good. As an advocate from within the bank, she got it. As a consultant, she's even better.

J Hagel



Recent Posts