Because it has become difficult to get
business loans through the normal
channels, you might be tempted to investigate and possibly take advantage of
alternative financing schemes. This course
of action might not always be prudent.
“It doesn’t hurt to look at alternative
lenders,” says Mike Petersen, a partner at
Shulman Hodges & Bastian LLP. “But first
consider your side of the lending relationship — particularly if you have deposits. Be
aware that credit is less available and lending terms are changing because of the state
of the economy. Valuations of assets are
changing, too, even though the assets themselves might not be changing.”
Smart Business talked to Petersen about
assessing the risks of taking out loans that
involve personal guaranties and hard
money.
What are personal guaranties, and how can
they put you at risk?
A personal guaranty means that you are
personally liable for the payment of your
company’s obligations. If the company
defaults on its obligation to pay a debt, a
personal guaranty allows the creditor to
bring legal action against you and your personal assets. Although retirement plans
offer some protection from creditors, most
other personal assets are generally subject
to this action, including homes subject to a
homeowner exemption, which in most
states is quite modest.
Before entering into a personal guaranty,
you have to realize that it is not for your benefit, but the benefit of the lender. If all goes
well, the guaranty doesn’t matter, but if your
company’s financial situation goes south,
the guaranty can hurt you significantly.
Most businesses start with an entrepreneur assuming a personal guaranty. When
the business becomes successful and viable
and has a credit line of its own, that’s the
time for the entrepreneur to get his or her
name off the guaranty.
How can a business owner limit the reach of
a personal guaranty?
You certainly want to be careful about
signing a guaranty without fixing finite
obligations.
If you have the bargaining power, you can
limit it to a fixed dollar amount, which can
be smaller than the loan. As credit gets
tighter, however, this option becomes less
feasible.
The other factor you could negotiate is a
homestead exception to protect your
house (and proceeds from the house if you
sell it and move elsewhere). Similarly, you
can carve out other assets from the reach
of the guaranty, such as a bank account set
up to provide college funds for children.
Finally, avoid self-renewing guaranties
that apply to loans beyond what you’re borrowing for today. That is something a wise
borrower should be able to negotiate, even
in these times. Without a sunset provision,
you can be held to a guaranty executed
years ago.
What about credit lines and company credit
cards?
Company credit cards often require a personal guaranty from the person to whom
the card is issued. When the card is issued
to a business and the business is in financial distress or financial extremes and
there is a high balance, you can get stuck
with paying the balance.
If you have a guarantied revolving credit
line, your obligation does not go away just
because you paid it off. The line will have
zero against it, but if you draw down on it
after it is reduced to zero, the guaranty still
applies to the new debt you’ve incurred on
that line.
You cannot afford to forget about any
guaranties you sign on or revolving lines.
The guaranty is on the line of credit established with the bank 10, 15 or 20 years ago,
and it is effective as long as the credit line
exists.
What is ‘hard money lending,’ and what are
the dangers of it?
Hard money lending refers to lenders that
are charging much higher rates of interest
than traditional lenders. They tend to quote
rates in percent per month rather than percent per annum — typically, 3 percent to 5
percent per month. These loans are
entered into on a short-term basis to meet
a particular business need or take advantage of a particular high-profit opportunity.
It is rarely the sort of loan a company
should take out, because the risk is so
great if things go badly: You can lose your
whole business and its assets.
What advice are you offering clients who
might be contemplating taking out a nontraditional loan?
The root cause of our problems today are
people who borrowed money that they
could not pay back. So don’t borrow more
than you are very sure you can pay back.
Look at the terms of the loan, including
its length. Examine the costs of borrowing,
like interest and various fees. Before signing the papers, consider scenarios where
your business might not do as well as
planned.
The higher the rate of interest and ‘cost’
of the loan, the greater the risk of something going wrong and the situation fast
becoming a disaster.
MIKE PETERSEN is a partner in the law firm of Shulman Hodges & Bastian LLP. Reach him at [email protected] or
(949) 340-3400.
