Why Do Creditors Require Personal Guaranties?
Updated: May 17, 2020
You probably will form a new corporation or limited liability company (LLC) when you start a business, buy a business, or buy commercial real estate. One of the reasons you do so is to protect your personal assets (e.g., cash in bank accounts, house, vehicles, etc.) from your business's liabilities. Don't be surprised, however, if creditors seek ways to get around that liability protection.
Creditors understand well that if they enter into a contract to extend debt to a corporation or LLC (e.g., a business loan, credit card, or lease) they might not be able to collect on that debt if the corporation or LLC defaults because (1) the entity may not have any assets to pay the debt, and (2) the entity will protect the owners so the creditor cannot get to their personal assets to satisfy the debt.
Creditors (including banks and landlords) get around the protection of your corporation or LLC by requiring each owner to sign a personal guaranty. The personal guaranty gives the creditor the right to collect the debt from the owner's personal assets. Most personal guaranties also allow the creditor to pursue the guarantor without exhausting its enforcement against the entity.
So you should expect to sign a personal guaranty when your corporation or LLC gets a loan or signs a lease. Without the personal guaranty, the creditor would not extend the debt because the borrower (your corporation or entity) would not be creditworthy. The personal guaranty allows the creditor to consider each owner's personal creditworthiness when underwriting the loan. It also gives the creditor some security that it can collect on the debt if the entity fails.
Even though a personal guaranty is customary in small business lending and leasing, you still might be able to negotiate the terms of the personal guaranty with certain creditors. For example, a landlord might be willing to terminate the personal guaranty after you have leased the space for a period of time (e.g., five years) without missing a rent payment or defaulting under other lease terms. Or, a landlord might be willing to cap the dollar amount of the personal guaranty. Note, however, that a bank will probably rarely, if ever, agree to negotiate a personal guaranty.
Personal guaranties are part of the cost of doing business. They should not surprise you. Read them closely to understand what you are promising and negotiate limits to them, if possible.