Many business owners have concerns regarding how a personal
guarantee works when doing a funding deal. It's very important
that you seek expert legal advice about the specific laws of your
city and state, as this article simply aims to provide an overview
of the basic issues related to a personal guarantee.
There are several details to consider, but the main line of
reasoning begins with the words "personal" and
"guarantee." These words mean what they say, so before
putting their signatures on financial documents for the company,
entrepreneurs need to consider very carefully the future potential
impact these two words could have. The main concern? Liability for
the obligation agreed to by the firm.
The first word, "personal," refers to you, the
individual, the owner of the company. It doesn't refer to your
board members, your senior managers or any of your employees. It
does not allude to the tax professional or attorney who provides
business advice. In the case of a proprietorship, the
owner/entrepreneur and the business are one and the same in the
eyes of the law. When Mary Owner signs for Mary Owner Services, the
line between personal and business is obviously not there. But even
in the case of a dba, an LLC or a corporation, the line can also be
very hard to find because it's not the company's name on
the signature line--it's your name out there all by itself.
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The second word, "guarantee," means "a pledge or
assurance." Therefore, the term "personal guarantee"
translates to you providing your own individual pledge or assurance
for an obligation. Depending on the exact wording of your financing
documents, you are personally pledging that you will make good on
the obligation, even if your form of business organization provides
limited liability protection under the law.
Businesses can be set up under different legal forms. Some of
these provide limited liability inherent in the structure to
protect and separate personal assets from those of the company.
Others, however, expose owners to unlimited liability, where
personal assets are unprotected from claims made against the
company.
For example, when Mary Owner operates her services company as
Big-Time Benefits (the dba for Mary Owner), there is no liability
protection inherent in the company's organizational structure.
(A dba is essentially a proprietorship with a different operating
name than the owner's name.) So even though the dba appears on
certain contractual documents, that business is still one and the
same with Mary Owner.
In the case of the partnership Big Time Benefits LP, Mary and
her partners (including general partners, who participate in the
daily management of the firm, and limited partners, who are simply
passive investors without any managerial oversight) may operate the
firm under that company name, but she and the general partners are
still one and the same with the business. The limited partners do
have specific legal protection from liability, but consult your
attorney about the specific laws in your city and state.
In the case of a corporation (depending on the form chosen and
the state in which incorporation is originated), the shareholders
are the owners of the company Big Time Benefits Inc., but the firm
itself is recognized as an independent, tax-paying entity under
most laws. Mary Owner may be a majority shareholder in the company,
but the corporate organizational structure does provide a level of
limited liability protection for her and the other shareholders.
Typically, the firm's name is on all the legal documents,
including employment agreements, financing contracts and the like.
In the event of a failure to make good on a certain obligation, the
liability belongs to the corporation.
Sometimes, however, a newly launched firm may be required to
have a personal guarantee on certain loans, credit cards or other
debt obligations. The general rule of thumb is that even though the
corporation provides liability protection to shareholders, any
individual who provides a personal guarantee--even if that person
is a shareholder--has contractually agreed to make good on the
obligation in the event the corporation cannot. Because the
personal guarantee is like a co-signer on a loan, the creditor will
come to this person once it's determined that the primary
borrower cannot meet the financial obligation. This could pertain
to an equipment lease, a partnership agreement with a person or
another firm, a real estate lease with a landlord, or various types
of loans.
Providing the personal guarantee is generally viewed as a
separate issue from whether or not the individual has limited
liability within the company's organizational structure. The
best approach is to make sure any company obligations are truly the
company's concern alone and that your individual name is not
included in the documentation. So when a personal guarantee is
made, be prepared to cover that obligation in the event the
business cannot.
David Newton is a professor of entrepreneurial finance and
head of the entrepreneurship program, which he founded in 1990, at
Westmont College in Santa Barbara, California. The author of four
books on both entrepreneurship and finance investments, David was
formerly a contributing editor on growth capital for Industry
Week Growing Companies magazine and has contributed to such
publications as Entrepreneur, Your Money,
Success, Red Herring, Business Week, Inc.
and Solutions. He's also consulted to nearly 100
emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those
of the author, not of Entrepreneur.com. All answers are intended to
be general in nature, without regard to specific geographical areas
or circumstances, and should only be relied upon after consulting
an appropriate expert, such as an attorney or
accountant.