One of the main reasons people form corporations and limited liability companies (LLCs) is to separate their business finances from their personal ones. Nobody wants a creditor coming after their bank account if their business fails and can’t cover its debts.
But that protection has limits. Business owners may be asked to contract away whatever protection the incorporation or LLC provides when taking out a loan, leasing a commercial space or establishing credit with a vendor via a personal guarantee. Once you sign on that dotted line, a debt that belongs to the business could eventually become yours.
What happens when you personally guarantee a debt?
A personal guarantee is essentially a promise that you’ll pay a business debt if the company doesn’t. It gives the creditor another source of repayment – you – if the business defaults.
These agreements are particularly common with new businesses or companies that don’t have substantial assets or a long credit history. A bank, landlord or vendor may simply be unwilling to take a risk on your company without it.
If the business doesn’t pay, a personal guarantee could result in:
- A lawsuit against you individually
- A judgment against you personally
- Collection efforts involving personal assets
- Liability for interest, late fees or other charges
- Responsibility for attorneys’ fees and collection costs
Not every guarantee works the same way. If several owners sign, don’t assume each person is responsible only for his or her share. A guarantee may create joint and several liability, which can allow the creditor to pursue one guarantor for the entire unpaid amount.
Leaving the company may not solve the problem, either. Selling your interest, resigning or otherwise ending your involvement with the business doesn’t necessarily release you from a guarantee you previously signed.
Know what you’re agreeing to before you sign
A personal guarantee shouldn’t be treated as just another signature page in a stack of business documents. Before signing, find out exactly what debts it covers, whether your liability is capped and when the creditor can pursue you personally. Legal guidance can help negotiate fair terms and keep you from making a potential mistake.