IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog has been provided by Robert Salier of the Pacific Northwest Law Group (www.pnwlg.com).
The Role & Risk Associated with Personal Guarantees in the Purchase or Sale of a Business.
Personal guaranties are common in the purchase and sale of a business. There are important implications of personal guaranties for both the person signing the personal guaranty (the Buyer) and the person requiring the personal guaranty (the Seller).
Background and Risks:
When a business is sold, there is a lot at stake. Oftentimes, the signature on a loan to purchase by an officer of the company purchasing the other company is not enough to satisfy the person or entity financing the purchase (this person or entity can be either a lender or if Seller-financed, the seller (who is now also a lender). Sellers/Lenders often also want the personal guaranty of one or more of the individuals associated with the purchase of the company. A personal guaranty on a commercial loan means that the lender will have the right to seek repayment from either the business assets or the personal assets of the guarantor should the loan debt not be paid on time. While taking on this kind of liability can be a stressful part of buying a new business, it is often necessary to ensure that the deal goes through.
When businesses and/or people take out loans, they usually believe that they will be able to pay the loan back. However, life happens, and sometimes these businesses are unable to pay back the debt as agreed to. If the business is in default on the loan, the lender may seek repayment from the personal assets of the personal guarantor. Needless to say, this can create a significant burden for many business owners and their families. While the family of the business owner may have the right to seek reimbursement from the company after paying for the defaulted loan debt, this may take many months, and if the business is struggling so that it cannot pay its bills on time, it may not be able to reimburse the guarantor or his or her family quickly either. There is also a risk of the personal guarantor dying and the lender being placed in line before the children and spouse of the deceased personal guarantor in receiving any assets of the personal guarantor’s estate.
In companies with many owners there is another potential risk. Often, the lender will ask that all owners of the Seller sign personal guaranties. If after signing the personal guaranties, one of the personal guarantors dies, the lender may have the right to call the loan and demand the repayment of the remainder owed on the loan. The lender may have to look to the business and to the personal guarantors to quickly repay the debt. In some circumstances, the lender may choose to obtain all of the repayment from just one guarantor. Again, in this circumstance the personal guarantor may be able to seek reimbursement from the company, but by this point there is often significant financial stress on the business and/or the personal guarantors and their families.
Reduce the Risks:
Key Person Life Insurance: One way for personal guarantors to reduce the risk of financial ruin due to the death of a fellow personal guarantor is to have the business purchase key person life insurance for the people making personal guaranties on behalf the company. With key person life insurance, you can ensure that surviving personal guarantors and/or their families will not be left with the debt of the business should the personal guarantor of a business debt die unexpectedly.
Needless to say, key person life insurance often benefits more than the personal guarantors, it also benefits the lender seeking to be paid as it creates a source of funds to ensure debts are paid even if key people are unable to continue working.
Joint and Several Liability: As a potential personal guarantor involved in a multiple person purchase of a company, you will want to avoid the term joint and several in personal guaranties. This term can permit the lender to seek the repayment from just one or all of the personal guarantors. If two of three personal guarantors are insolvent, the lender would be able to seek repayment from only one of three personal guarantors. This catches many personal guarantors off-guard as they are often under the assumption that any amount owed due to business default would be shared equally by the personal guarantors. The Buyer(s) may also enter into a debt allocation agreement to be responsible only for their proportionate share of the seller’s note, and obtain Seller consent to such an allocation.
Negotiate a Termination Date: Some lenders may be willing to accept an end date to the personal guaranty before the expiration of the Seller note. This means that once a certain amount of time has passed without default, the personal guaranty will no longer be valid, and the lender can look to the business only to pay back the debt.
Negotiating a reasonable termination date can benefit both buyers and lenders. Sometimes giving an end date to the personal guaranty encourages the buyer to sign the personal guaranty and move the deal forward, as she or he knows there is an end date to the obligation.
Personal Guaranty Insurance: For buyers, it may also make sense to consider personal guaranty insurance. This type of insurance helps protect your personal assets should the business debt be called.
Again, this type of risk reduction is welcomed by lenders as it helps ensure they will be paid, even if the company itself cannot afford its payments anymore.
As most business owners know, owning, managing, selling, and purchasing companies involves risk. With proper planning and negotiation, the risks associated with personal guaranties can be mitigated for both sellers and buyers alike.
If you have questions related to any of the legal implications affiliated with signing or obtaining a personal guarantee as part of a business sale or purchase Bob Sailer would welcome the opportunity to discuss the situation with you. Mr. Sailer can be reached at (425) 867-0512 or Bob@pnwlg.com .