The experienced business owner is no stranger to signing personal guarantees. It has become standard practice for lenders to require owners, and even their families, to sign a personal guarantee (PG) to secure a commercial loan.
While this is often the price of doing business, what does a personal guarantee mean to business owners, partners and even family members? What, if anything, can be done about them?
While they are nothing new, PGs have become commonplace as tight credit conditions have forced banks to become increasingly conservative in their lending practices.
A PG is a note signed by a business owner, partner, investor or family member – also known as a loan guarantor –– that puts up personal assets in addition to business assets as loan collateral. If the loan defaults, the bank can then go after things like homes, bank accounts and investments – and they don’t even have to wait until the business assets have been liquidated to address the outstanding debt.
As a PG being called can have grave consequences, small business owners owe it to themselves to develop a PG negotiating strategy before sitting down in front of a loan officer. The following five steps are a practical guide for walking through the negotiating process in order to get the best deal possible while lessening the risk of losing hard-won personal assets.
How To Negotiate a Personal Guarantee
1. You Need to Know What You’re Signing
There can be a wide variance in the terms of a PG. For instance, they may permit the bank to go after personal assets even if there isn’t an outright loan default. Triggers can include a technical default, additional borrowings, sale of assets, death or incapacitation.
Other times, the PG can allow the pursuit of additional collateral on demand if the lender believes the loan is under-secured. While many business owners mistakenly believe incorporation acts as legal protection that prevents a lender from pursuing personal assets, this is not the case when a PG is in force.
2. Know Who You Are Signing With
In partnership scenarios, each person usually signs a “joint and several” PG agreement. You might think that this spreads the risk out evenly among the partners, but that is not the case.
In fact, the lender is free to pursue whichever partners it wants and those with the most liquid assets are usually the most vulnerable. As a result, a partner can find himself in the difficult position of pursuing relief from other partners – who are often friends or family members – on his own.
3. Determine an Acceptable Level of Risk
As a business owner or partner, you need to determine your own acceptable risk threshold, both on a business and personal level, before approaching the bank. This means calculating the assets you would need to satisfy the PG. You also need to bear in mind the fact that if the business is challenged – more than likely the case if the loan is being called – its assets will be worth much less than book value.
Based on this assessment, you can calculate how much of your personal assets to risk on the loan and still sleep at night.
4. Negotiate the PG Terms
While nearly every term in the PG can be negotiated, you need to figure out which ones are most critical to you as well as which ones the lender will not likely want to change. Armed with this knowledge, you can map out your strategy for negotiating both the PG and the loan documents.
Here are a couple negotiating tactics to consider:
Limit the guarantee: Banks will always want an unconditional or unlimited guarantee, but you can ask that it be limited either in terms of actual dollars or based on a percentage of the outstanding loan. In a partnership situation, you can ask the lender to limit the amount of exposure based on the size of each partner’s owner ownership stake.
Suggest terms of relief: Ask to be relieved of the PG after a certain percent of the loan has been repaid. You could also suggest that it be reduced as a key financial metric improves, such as your debt-to-equity ratio. Another option could be to ask that the amount or percentage of the PG be decreased after five years of issue-free loan payments.
5. Keep the Door Open to Future PG Negotiations
Even after the PG is signed, you can always approach the bank to reopen negotiations of loan and guarantee terms based on changes in your situation such as improved financial performance or increased collateral. Having personal guarantee insurance can also allow you to seek loan/PG concessions.
| Negotiation Steps | Description |
|---|---|
| Know What You’re Signing | Understand the variability of PG terms, including triggers that allow lenders to target personal assets beyond loan defaults. Recognize that incorporation doesn't shield personal assets when a PG is active. |
| Identify Parties Involved | Comprehend partnership dynamics—signing a "joint and several" PG doesn't evenly distribute risk. Lenders can target partners with more liquid assets, potentially leaving certain partners vulnerable. |
| Assess Acceptable Risk | Determine your risk threshold on both personal and business levels before approaching the lender. Account for potential depreciation of business assets if challenged, recalibrating the calculated risk on personal assets needed to satisfy the PG. |
| Negotiate PG Terms | Identify crucial terms to negotiate based on your priorities and lender's preferences. Develop a negotiation strategy encompassing PG and loan documents. |
| Strategize Relief and Future Negotiations | Employ negotiation tactics: Limit the guarantee amount or request terms of relief—e.g., PG relief after a certain loan repayment percentage. Keep avenues open for future negotiations, reengaging with the bank as situations evolve or financial performance improves. Personal guarantee insurance can facilitate seeking loan concessions. |
Frequently Asked Questions
What is a personal guarantee (PG) in the context of commercial loans?
A personal guarantee is a legally binding agreement signed by business owners, partners, investors, or family members (loan guarantors) that pledges personal assets alongside business assets as collateral for a commercial loan. If the loan defaults, the lender can pursue personal assets like homes, bank accounts, and investments to recover the outstanding debt.
Why are personal guarantees commonly required by lenders?
Personal guarantees have become standard practice due to tight credit conditions, leading lenders to adopt more conservative lending practices. By obtaining a personal guarantee, lenders can secure additional collateral beyond business assets to mitigate their risk in case of loan default.
What are the potential consequences of a called personal guarantee?
When a personal guarantee is enforced, it can have significant financial repercussions. Lenders can seize personal assets, including homes and investments, to cover the unpaid loan amount. Business owners, partners, and family members who signed the guarantee are at risk of losing their personal assets.
How can business owners negotiate favorable personal guarantee terms?
To negotiate a personal guarantee effectively, follow these steps:
Step 1: Understand the terms: Personal guarantees can have varying terms and triggers. Familiarize yourself with the terms, such as when the lender can pursue personal assets.
Step 2: Identify parties involved: In partnerships, all partners usually sign a “joint and several” PG, which means the lender can pursue any partner individually. Be aware of this and consider the implications.
Step 3: Determine risk tolerance: Assess your acceptable level of risk both personally and for your business. Calculate the assets needed to satisfy the guarantee and consider the potential depreciation of business assets.
Step 4: Negotiate terms: Negotiate critical terms of the personal guarantee with the lender. Consider strategies such as limiting the guarantee amount or suggesting relief terms based on loan repayment progress or financial metrics.
Step 5: Keep negotiations open: Even after signing a personal guarantee, continue to monitor your situation and approach the lender for renegotiations based on changes in circumstances, improved financial performance, or increased collateral. Personal guarantee insurance can also aid in seeking concessions.
Can personal guarantee terms be negotiated with lenders?
Yes, personal guarantee terms can often be negotiated. While lenders typically aim for unconditional or unlimited guarantees, borrowers can negotiate limitations on the guarantee amount or terms for relief, such as reducing the guarantee as loan payments are made or as financial metrics improve.
What options do business owners have to minimize personal guarantee risks?
Although it might not be possible to completely avoid personal guarantees, business owners can take steps to mitigate risks. Seeking advice from professionals like attorneys or accountants, developing a well-thought-out negotiation strategy, and exploring personal guarantee insurance are all effective approaches.
How can a business owner approach renegotiations after signing a personal guarantee?
After a personal guarantee is signed, borrowers can approach the lender to reopen negotiations based on changed circumstances, improved financial performance, or increased collateral. Personal guarantee insurance can also facilitate seeking concessions from the lender.
What resources can business owners utilize for successful personal guarantee negotiations?
Business owners can benefit from seeking advice from qualified professionals such as attorneys, accountants, or financial advisors. These experts can provide valuable insights and assistance in developing a strategic approach for negotiating personal guarantee terms and loan conditions.
What is the importance of carefully planned negotiation strategies for personal guarantees?
A carefully planned negotiation strategy is crucial to secure the best possible terms for personal guarantees and commercial loans. With expert guidance and a well-thought-out approach, business owners can minimize risks and protect their personal assets while navigating the complexities of personal guarantee agreements.
Are personal guarantees unavoidable in the current economic climate?
While personal guarantees might not be entirely avoidable given prevailing credit conditions, business owners, partners, and family members have options to mitigate risks. By seeking professional advice and following strategic negotiation tactics, individuals can navigate personal guarantees while safeguarding their personal assets.
Conclusion
In the dynamic landscape of business, personal guarantees (PGs) have emerged as an indispensable facet. Seasoned business owners, familiar with this practice, recognize its resonance in modern lending dynamics. The collateralization of personal assets alongside business resources has become an essential safeguard for lenders, fostering prudence in times of economic uncertainty.
As lenders increasingly demand PGs from business owners and their families, the implications cascade beyond financial realms. This practice necessitates a nuanced understanding, prompting proactive strategies. The negotiation process unfolds through five pivotal steps, each weaving a strategic narrative to safeguard personal assets while optimizing loan terms. From deciphering intricate PG terms to fostering open avenues for future renegotiations, the adept business owner orchestrates a symphony of financial acumen.
Through the art of negotiation, personalized and strategic, business owners sculpt terms that reflect their unique risk tolerance and ambitions. This process extends beyond signatures, inviting continuous dialogue with lenders based on shifting circumstances. In a landscape where PGs intersect business aspirations and personal commitments, the experienced entrepreneur leverages insights, collaboration with advisors, and strategic finesse to navigate these waters.
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This article, "You Can Use These 5 Steps to Negotiate a Personal Guarantee" was first published on Small Business Trends