Personal Guarantees . . .

are promises made by an entrepreneur or founder that obligate him personally to repay debts defaulted upon by his corporation.

Entrepreneurs who incorporate their companies to avoid becoming personally liable for company debts are often disappointed when they look for financing. This is because many lenders and lessors require personal guarantees as a condition to lending or leasing to small private companies. Even some venture financings, those that include a substantial amount of debt, require personal guarantees for the loan portion of the funding. These guarantees require the entrepreneurs to pay off the loans if their companies default.

Not all personal guarantees are equal, however. Entrepreneurs should be aware of the concessions lenders sometimes make so that they can negotiate to reduce their personal exposure under their guarantees. For example, when two or more company officers are asked to guarantee a single loan each officer may be liable to repay the entire amount of the loan or just a pro rata portion of it. It depends on how the guarantee is worded. Also, the availability of company assets to secure part of a loan can sometimes be used to limit a guarantee to a portion of the dollar value of the loan. On long-term loans, provisions can sometimes be negotiated that cancel the guarantee upon the happening of some future event, such as the passage of time, the infusion of new equity into the company, or the payment of a portion of the loan.

Personal guarantees are not required in equity financings. Many venture financings, however, are made up of debt and equity. As a result, venture capitalists that fund companies with both debt and equity sometimes ask management to guarantee the debt portion of the financing. A personal guarantee in such a situation, however, may not be appropriate. If the funding is essentially a debt financing with attached stock rights given as a bonus, a guarantee may be unavoidable. When a financing is essentially an investment of equity with a portion characterized as debt to "sweeten the deal" for the investor, management is justified in objecting to guaranteeing the "debt" portion of what is really an equity financing. See: Buy-Sell Agreements, Nonrecourse Debt.