To all small business owners everywhere, please beware of the personal guarantee. Some of you are well aware that you are personally guaranteeing your commercial leases, your company credit cards and any loans.
But some of you take credit out under the company name and think you can walk away when things go south. Wrong. At least in theory this is correct but in practice it is anything but correct.
The banks and credit card companies got smart a long time ago. If you are a new business or a small business the credit card company has you on the account as a signer. If you gave your social security number as well as your FEIN to get the credit, you are on the hook for the funds whether or not the company is open and operating.
Let’s take a look at how this works.
When you create a company, the company is a separate legal entity. This is true of all LLC’s, S corps and LLP’s.
C corps are always separate legal entities because they are usually large companies where the ownership is very different than the owner/officer set up of a smaller company. However, sometimes a small company can be a C Corp, usually attorneys or real estate investors but even they have to sign a personal guarantee when getting a commercial lease.
Sole proprietorship are the same legal entity as the owner so of course you are on the line for the money.
In my 20 years of being a controller, I have never seen a commercial lease without the owner personally guarantee it. What this means is that if you sign the lease and default, the landlord can come after you as an individual for the remaining rent. They cannot take your primary house from you but they can put a lien on it and collect the money from the sale of the house.
So what does this mean for the small business owner.
- Read the fine print. Understand what you are liable for and what you aren’t liable for.
- Set a budget. How much debt are you willing to take on to get your company up & running. If you are already successful, how much will you personally put up to help the company when things go bad.
Beware, when you sign a personal guarantee, that includes all of your assets listing on your PFS = personal financial statement. If your house or other properties are listing, then they are fair game when it comes to debt collection.
Credit cards: guys if you take out a credit card for the company and your name is on it, you are responsible to pay this off whether or not your company survives or not. Please don’t listen to the attorney who thinks in theory you can walk away. You can walk away if you are separate legal entities and you did not sign a personal guarantee. But the banks and credit cards have been doing this a very long time. They learned the hard way and they are one step ahead of you.
Be aware of what you are agreeing to. Make sure that your spouse/significant other is on board too. If one of you is a risk taker and one of you is conservative, meet in the middle. Find a common ground where your life savings is not all at risk but you can put an amount towards the company to help it succeed and still not endanger your life savings. Draw a line and keep it until you get to the point where you need to reassess.
If you are in LA or New York, borrowing $250k off your house is not a big deal. Doing this is the Midwest on a $400,000 home is crazy, depending upon your temperament.
So, know yourself, know your numbers and know the risks. Make a plan on how you can make it work with what you have.
Then get our there and make your business very successful so that this is a thing of the past.
Deb
