Credit Worthiness and Personal Guarantees
As a small business owner, it’s important to pay attention to your personal credit as well as your business credit. For example, if you’re a sole proprietor, your personal credit history and your business credit history are closely linked in the eyes of your bank. However, many Main Street business owners rely too heavily on their personal credit to run their business—which could put your personal assets at risk should you ever find your business in trouble.
Additionally, when you’re starting out, or when your business is very young, your banker might ask for a personal guarantee (in fact, I’d expect it). Basically, you’re telling your banker that you will personally be liable should your business default on your loan.
I recently heard from a small business borrower who fell behind on a substantial loan and is now facing foreclosure. The commercial property that was used as collateral has been substantially devalued over the last few years and will likely only cover 50-60 percent of the loan amount. His personal guarantee put his personal assets at risk, and his attorney is warning him that he will likely lose everything.
This isn’t an uncommon situation for many small business owners. I regularly hear of entrepreneurs who for one reason or another have defaulted on a small business loan and are in trouble. They often try to finance their way out with additional debt, but it often seems to only make the situation worse. However nobody likes to admit defeat—especially when your home and possessions are on the line.
I have a very close friend who happens to be a pretty smart accountant. He would say that inadequate cash flow kills more businesses than anyone might expect. Many good ideas never make it past the second or third year simply because they are underfunded with no means to secure more capital. Small business debt is often a viable solution, but the real key to managing business debt is to tread carefully and remember, for most Main Street businesses, your personal and business credit are closely tied together.
What are you doing to walk the tightrope? At what point in your business growth did the bank stop asking for a personal guarantee?