Understanding Personal Guarantees
There was a time when entrepreneurs and small business owners were able to negotiate commercial leases without a personal guarantee. Landlords were often willing to forgo a guarantee in exchange for higher rents, longer lease terms, or larger common area maintenance (CAM) fees, but now…? Well, let's just say that the times, they are a-changing.
Landlords, like banks, think in terms of “reasonable risk.” If your business fails and defaults on its lease, then your landlord is liable for the balance, and recently, the collapse of the commercial real estate market has caused landlords to reconsider what constitutes a reasonable amount of liability.
Is it possible to negotiate a true no-personal-guarantee lease? Absolutely!
Across the county, from New York to California, skittish landlords are demanding personal financial guarantees from business owners, even if the business in question has been organized as a Limited Liability Company. And even if you have a strong record of repayment and your business is in the black, a landlord may require a time-limited guarantee in order to reduce their own financial risk.
If your landlord absolutely will not budge, then it is always possible to negotiate the terms of your guarantee to limit its impact on your personal finances, your business's operational capacity, or both. Here are some options for finding a compromise that satisfies your landlord while protecting your personal assets.
Negotiating the Terms of Your Personal Guarantee on a Commercial Loan
Just because your landlord is demanding a guarantee does not mean that you cannot negotiate a creative, mutually-beneficial lease.
- Request a time-limited guarantee. Ask your landlord to reduce the period covered by the personal guarantee to one or two years, rather than the entire term of the rental. Most unsuccessful businesses fail within the first two years, so it is entirely reasonable to request that your guarantee expire after 18, 24, or 30 months, provided that all other payments and fees are up to date.
- A landlord may be willing to accept a so-called “good guy” guarantee. This agreement holds the guarantor liable until the tenant has lawfully left the premises. This protects the landlord from “cut-and-run” defaulters. If your business is failing, or if you need to relocate to another space, the landlord agrees not to enforce the guarantee, provided that you pay your rent until the agreed-upon departure date.
- You should always ask that your guarantee be waived upon transfer of the lease. If you sell your business to a new operator, or if your landlord transfers ownership or management of the space to a new lessee, then you don't want to be stuck guaranteeing anything!
So the question still remains… Is it possible to negotiate a true no-personal-guarantee lease? Absolutely! But it's not easy. For first-time entrepreneurs, a personal guarantee may be unavoidable, but if your business has a demonstrable record of repayment, adequate capital, and a strong balance sheet, you may be able to convince a landlord to waive the guarantee entirely.
Typically, a landlord will ask that you offer a retainer or a larger security deposit in lieu of a personal guarantee. The down side? This means tying up cash that could otherwise be accumulating interest.
You need to keep your balance sheet in mind and make sure that a cash deposit will not undercapitalize your business. The number one reason why unsuccessful small businesses fail? Insufficient working capital. If possible, it is always best to offer non-cash corporate assets—equipment, for instance—as collateral, rather than a cash deposit.
When all is said and done, your peace of mind is invaluable. As the business owner, you need to be able to objectively appraise your business, make decisive decisions, and stand behind your choices.
Seeing clearly and acting with certainty will always be more difficult when your personal wealth and personal assets (and, by extension, the financial security of yourself and your loved ones) are at stake. In the end, you may decide that it is best to sacrifice a small amount of working capital for the sense of well-being afforded by a no personal guarantee loan.
Have a great story about how you and your business dealt with a commercial lease? Consider sharing it with us today, and offer a guest blog post at The Self-Employed blog.