Most credit applications contain a personal guaranty. In
this one, it's clearly spelled out in item No. 4, but in some
cases it's buried in a longer document and written in language
that makes it hard for the applicant to understand just what
he's agreeing to.
When the owner of a new or small business applies for credit,
he or she is frequently asked to provide a personal guaranty.
The guaranty is a contract between the owner and the creditor
that in essence says, "I agree to be personally responsible for
the debts of my business, so if the business doesn't pay, I
This has little effect on sole proprietors because their
personal assets are already at risk for their companies' debts.
But a guaranty presents a dilemma for the contractor who has
incorporated as a corporation or limited liability company
(LLC). These business entities are designed to prevent
creditors from accessing the owner's personal assets. When an
owner signs a personal guaranty, he is giving this access back
to the creditor.
The trick for the small-business owner is to understand when to
give the guaranty.
Why Creditors Want a Guaranty
Creditors often request a personal guaranty when the
creditworthiness of the business is limited. The guaranty is
used to enhance credit by making personal assets —
otherwise unavailable to the creditor — available to
satisfy the debt.
Assuring payment. There are other reasons
creditors might want a guaranty. For example, they might want
to use it as leverage to assure payment. They reason that if a
business owner has to pay two debts, he will first pay the one
that puts personal assets at risk. If the business goes under
before the second creditor gets paid, that's just too bad
— it's the second creditor's problem.
It's worth noting that if the business does file for
bankruptcy, the court may undo recent preferential
In leasing transactions, a guaranty for moveable equipment may
provide greater assurance that the equipment will not
"disappear" if there is a default by a failing company. In
other transactions, the reason is simply "Let's put it on our
form and see if we can get it."
Form of Guaranty
When a bank or equipment-finance company requires a guaranty,
the guaranty is typically on a separate form or in a labeled
section of the loan agreement and is often several paragraphs
Trade creditors, such as supply houses and lumberyards, often
bury a single-sentence guaranty in the credit application form;
it's easy to miss if you don't read the fine print. The
sentence may say something like this: "The undersigned, even if
a title is stat-ed, personally guarantees the prompt payment of
all amounts due from the applicant and agrees to be jointly and
severally bound with the applicant for any debt owed by the
Who should sign. If a guaranty must
be signed, a business owner should be the guarantor — not
a nonowning officer or employee. The bookkeeper or salesperson
who signs and submits the credit application with a guaranty
for the boss could be in for a surprise when he or she becomes
liable for the company's debts.
If there is more than one owner, it is usually best to make all
owners liable and to share the risk, preferably in a ratio
reflecting the ownership of the business, although most
creditors will require joint and several liability.
You may want to consult an attorney to draft an agreement
between the owners that says that if one owner provides a
guaranty on an authorized debt, all the owners will be
responsible to him if he has to pay a share in excess of the
percentage he owns.
Limiting Potential Damage
There are ways to limit the potential damage of a guaranty. The
party requesting a guaranty will want it to be completely
unlimited, but remember that this is a contractual agreement,
so it should be negotiable.
If you do have to sign a guaranty, you want it to end as soon
as possible; a guaranty puts personal assets at risk, and
having too many of them can make you less creditworthy for
Expansive guaranty. A guaranty may be
very expansive. It may cover all debt, including previously
existing debt or other debt that one of the owners owes the
lender. You may be able to limit the scope of the guaranty to
that transaction only.
The point is to carefully read all guaranties. If you have any
questions, consult an attorney.
You may be able to avoid giving a guaranty to a banking lender
by showing creditworthiness. If your entity has a net worth of
$100,000 and you sell only on a cash basis, there is probably
not much risk to a creditor if you want an open credit of
$10,000. But if you want to borrow $1 million to build your own
building, you should expect to give a personal guaranty.
Other situations may not be as clear for the small-business
Ending the guaranty. Many lenders require a
personal guaranty for real estate and development loans if the
borrower doesn't have a large equity stake in the property.
Equipment-financing transactions may also require a personal
guaranty. You may be able to arrange a "burn-off" of the
guaranty — that is, a guaranty that ends before the final
payment or when the "equity investment" exceeds a stated
percentage or dollar amount. This is good because it makes the
guaranty end sooner.
Leasing agreements. If you have to
sign a guaranty in connection with an equipment lease, be sure
to maintain control over the equipment so that you can return
it. If someone else ends up with the equipment and won't give
it back, you're the one who has to pay.
The Client's Debts
If you're a remodeler, you do not want to guaranty the debts of
your customers. But you may already be doing so if you are
ordering nonreturnable items or making deposits with your own
money based on the property owner's promise to pay you.
I tell my contractor clients to include language in their
contracts requiring the customer to pay all deposits and
potential restocking fees in advance, and then to collect those
amounts before placing the order. If there is going to be a
very large dollar order from a particular supplier, you might
want to have the owner open an account with that supplier and
pay him directly. Just be sure that your contract allows you to
mark the material up.
Lien rights. In many states, if the
supplier delivers material to a remodeling site (rather than to
your warehouse), the supplier will have lien rights against the
property owner. You may be able to convince a supplier to open
a separate account that you do not personally guaranty for
material that will be delivered to sites where there's a lien
right against the owner.
Credit cards opened in the name of the business may in some
instances have a personal guaranty. Be cautious giving these
cards to an employee. You may want to explore whether a credit
card can be limited to the assets of the business, even if it
costs you an annual fee.
At minimum, be sure that these cards do not have excessive
Kevin M. Veler is an Alpharetta, Ga., attorney
with 20-plus years of experience representing companies in
construction, real estate, and general business