Let’s say you are an aspiring entrepreneur and you have an idea for a small business. You work on your business plan, get approved for some financing at the bank and as everything looks promising, you are ready to start looking for commercial space. After your commercial realtor finds you the perfect space, you negotiate a deal with agreeable terms but one issue has come up that you didn’t foresee – a personal guarantee. Today we are going to discuss personal guarantees.
What is a Personal Guarantee/Indemnity?
A personal guarantee (also often referred to as an indemnity), is really exactly what it sounds like – an unsecured written promise from an individual to repay any obligations of a business. So in the above case, should your business not go as planned and you decide to close down, you will be personally liable for the lease obligation remaining. When we say the guarantee is unsecured, we mean that your guarantee is not tied to a specific asset (ie your home) but in the event of default the landlord could go after any of your assets to settle the debts.
Why Would a Landlord Want a Personal Guarantee?
A personal guarantee is essentially an extra level of security for the Landlord. These are especially prevalent and common when doing leases with small businesses. Small businesses generally have less in the way of assets and therefore the financial health and creditworthiness is tied to the owner’s personal finances.
Take the example of a new startup business with zero in assets and the landlord who is agreeing to renovate the space on the behalf of the tenant for their needs. There is high risk of failure in this situation, and as such it is prudent for the landlord to request a personal guarantee. It should also be noted that in the above example, when the tenant was approved for financing from the bank, this would’ve come with personal guarantees at the bank without a doubt!
Once a business is established with assets and a history of profits, the needs for a personal guarantee is lessened. At that point, a landlord and likely the lender as well will look to the financial health and creditworthiness of the corporation. A personal guarantee is also less necessary in certain other situations, like when a tenant is renovating their own space or if the term is short enough to not have it worthwhile.
What Else Should I Know About Personal Guarantees?
The issue of personal guarantees is a term that should be discussed as part of an offer to lease. That way there are no surprises when the lease draft comes out. A personal guarantee can also be offered by a third party. Take the example of a young professional with limited assets or credit history and their parent agreeing to personally guarantee their lease. Lastly, a personal guarantee can be negotiated for a period of time (ie say you signed a 10 year lease, but only agreed to a personal guarantee for the first 5 years).
Make sure if a personal guarantee is applicable to your lease deal that your commercial realtor negotiates the terms on your behalf. And also make sure your lawyer signs off on the clause or related indemnity agreement in your lease. In the (hopefully unlikely) event that it becomes an issue, you’ll be glad you did.
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