Lenders view loans to small businesses, particularly start-ups, as among the riskiest they make, particularly when there is little or no credit history or business revenue on which to base their decision. To lessen their risk, lenders almost always require a small business owner to sign a personal guaranty as a condition for granting the loan.
A personal guaranty is a legal commitment by a business owner to repay a business debt if the business cannot repay it. A personal guaranty puts some of the personal assets of a small business owner on the line.
Examples of personal assets at risk may include bank accounts, cars, and real estate – but not Homestead property in Florida.
A small business owner may take some or all of the steps below to lawfully minimize their liability.
- Request limitations on when the guaranty goes into effect. Try to include terms allowing the personal guaranty to be utilized only once a certain number of payments have been missed or if the net worth of the business decreases below a specific amount.
- Ask for the personal guaranty to be decreased over time as the business grows. Once your business has stabilized and established a good record of creditworthiness, the personal guaranty could be reduced.
- Seek a limited personal guaranty based on ownership percentage. Unless you negotiate other terms, lenders are likely to establish an unlimited personal guaranty. This allows the lender to collect 100% of the loan amount, and attorneys’ fees, from an individual business owner, even if there are multiple owners. Avoid this “joint and several” liability, which allows the lender to recover the full amount from you if the other owners no longer have sufficient personal assets to cover the loan. With an unlimited personal guaranty, even if you only have a 50% stake in the business, you would be personally liable for the entire loan. Instead, seek to limit your personal liability based on your ownership percentage in the business.
- Ask for certain assets to be excluded from the guaranty. Florida’s Constitution provides an exemption for a guarantor’s Florida Homestead (primary residence in Florida) to be exempt from being sold to meet the demands of third party creditors. There are other exemptions provided by Florida law.
- Agree to pay a higher interest rate–you may eliminate or limit the need for a personal guaranty by doing so. Evaluate the pros and cons of a higher interest rate, however, as the profits your business generates will be reduced by higher interest payments.
Remember, establishing a business structure providing limited liability, for example, an LLC, will not protect you from liability under a personal guaranty. Even without a personal guaranty, a single-member Florida LLC does not limit the member’s liability anyway. There must be at least two members for a Florida LLC to offer limited liability.
Conclusion
Lenders are likely to include terms in small business loans providing extensive personal liability. It is essential to seek legal counsel to explain the full ramifications of a personal guaranty before you sign on the dotted line. We can help you negotiate terms that will minimize your liability and maximize protections for your assets (and your credit rating). Contact us today to set up a meeting at (813) 852-6500.
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