It’s a fact of life that a banker, lender or lessor will ask for a personal guarantee from the founder or entrepreneur most every time. But what if you’ve diluted your interest from 100% to something less than 50%?
Should your investors expect you to carry 100% of the risk?
The short answer is “yes.” Seems unfair, doesn’t it?
To most lenders, the guarantee is still a requirement, putting the entrepreneur in a position of additional risk that is not spread among the shareholders.
Recently, one of my companies offered the founder with a 20% remaining interest after several rounds a reward for signing two large personal guarantees necessary to grow the business—in the form of a warrant to purchase common shares at today’s common share price. A win-win for the investor and entrepreneur assuming the company does grow and have a liquidity event someday.
The eye-opening process of borrowing for a small business
Starting and running a small or growing business can be a challenge to the most confident and optimistic entrepreneur. And the process of borrowing money or financing asset purchases can be an eye-opener for those who are not used to today’s lender and seller aversion to grant easy credit.
The easy solution when entrepreneurs have controlling interest
Most any entrepreneur with a clean credit record can obtain a bank card with a $50,000 limit, if s/he is willing to give a personal guarantee and has enough assets to back the promise it contains. As the amounts get higher or as banks get into the picture, the negotiation around a personal guarantee becomes more of an issue with the lender and the entrepreneur. As a rule of thumb, a company with a majority owner in control will be required to provide such a guarantee for most any borrowing of significant size in relation to assets.
Some thoughts on elimination of personal guarantees
All entrepreneurs assume risk when starting and growing a business. It is only smart to consider ways to mitigate risks when opportunities to do so arise. Approach your banker when times are good and discuss whether the increased collateral from growth is enough to eliminate the guarantee. Approach your co-investors to negotiate some mitigation of personal risk, such as a backup guarantee in return for warrants. Consider approaching another bank or lender with your increased strength and negotiate a “take-out” loan that eliminates the original lender without requiring a personal guarantee.
Most of all, keep your line of credit clean. Communicate with your lender if a payment is going to be late. And of course, here’s that old adage: “Never run out of cash.”