When speaking to a client about starting their business, I often discuss the different structures available (e.g. sole-proprietorship, partnership, corporation, etc…), as well as the various benefits and drawbacks for each one. One of the main advantages of incorporating, beyond certain tax benefits, is limiting the liability of the corporation’s shareholders. Unfortunately, there are some situations where the individuals involved in the corporation could still be exposed personally. One of the most common is a personal guarantee.
A personal guarantee is a promise from an individual to be responsible for the debt and/or obligations of a corporation in the event the corporation is unable to repay its loan or fulfill its commitments. This is usually required in a variety of situations, but most commonly when lenders wish to loan money or when a landlord wishes to lease a commercial property. The reason for requesting this is similar to what many of us experienced when we first started out on our own, whether it be going to university or renting an apartment for the first time. At that time, most of us did not have much of a credit history, so our parents likely had to co-sign on a loan for tuition or on a lease for a tiny apartment. That way, if we did not pay, the lender or landlord would have someone else to pursue with the means to pay whatever was owed. The same logic applies for a personal guarantee in support of a corporation. Since the lender or landlord may have concerns about the corporation’s ability to fulfill its obligations, they often need extra protection in the form of a personal guarantee (as well as other types of security, such as a mortgage or general security agreement).
Unfortunately, personal guarantees are a common requirement and difficult to avoid when operating a corporation. However, depending on the circumstances, there may be some ways to limit your personal liability. One is to try to limit your guarantee to a certain amount of money. Most entities will require you to provide an unlimited guarantee (meaning you are personally responsible for all amounts owing) but you may be able to negotiate to reduce this to a specific dollar amount (so that any amount above that would not be your responsibility). Also, you may be able to limit the amount of time your personal guarantee is in effect. Most personal guarantees are in place until all obligations have been satisfied (such as payment in full) but it may be possible to set an end date (e.g. the personal guarantee expires after three years).
In closing, personal guarantees play an important role in most businesses and it is important to understand the ramifications associated with them before agreeing to provide one.