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Last month I wrote about why lenders may require a personal guarantee. Agreeing to these contract clauses ties your own money to the health of your company, effectively turning a business loan into a personal liability.

Putting your own money on the line for the sake of your company is a risky proposition. Business setbacks are financially and psychologically taxing even without the threat of losing your personal assets as well.

Don’t want to risk losing your own hard-earned money if your business fails? Here are some strategies that—individually or in some combination—may allow you to avoid a personal guarantee:

Buy insurance

If the lender’s concern is not being repaid—especially when the lender is either lending against a company’s accounts receivable or purchasing invoices to fund working capital—purchasing credit insurance on your customers might alleviate the concern. In Canada, there are several companies that sell credit insurance, including Coface, Euler Hermes and Export Development Corporation (EDC).

Raise the interest rate

A lender must weigh the risk of their loan against the return, and may see a personal guarantee as a way of reducing the risk. But there is another way to balance that equation. Instead of lowering the risk, offer to pay more interest to offset the perceived increase in risk of not having a personal guarantee.

Increase Reporting

One of the main risks a lender faces stems from not being involved in the day-to-day operations of the your company. The lack of access means the lender has no way of knowing about events that put the loan at risk of non-payment—they will not find out about a default or downturn until long after it has occurred.

Agreeing to more onerous or frequent reporting allows your lender to have more of a real-time understanding of the business. Here are some examples of reporting structures that will give a lender greater confidence in your firm:

  • Instead of monthly reporting of financial statements, which always leaves the lender a month behind the state of the business, suggest weekly reporting.
  • Instead of providing bank statements by the mid-point of the following month, provide real-time online read-only bank account access.
  • Instead of Notice to Reader financial statements, agree to conduct a full audit.
  • Agree to allow random field audits with little or no notice.

Increased the Frequency of Payments

A typical structure for loans is to pay interest monthly in arrears. This means that a lender won’t know that something is wrong with your business until an interest payment is missed—usually at least a month after the problem occurs.

A personal guarantee helps the lender bridge that gap of unknown time. But if you increase the frequency of payments, your lender will be able to find out quicker if there is a problem and the magnitude of the loss may be much lower. For example, some popular online US lenders take daily repayments debited directly from the company’s bank account each night.

This structure also has the added benefit of reducing the value of each repayment. That means you don’t have to worry about ensuring there is enough cash at the end of each month to pay the previous month’s interest.

Add a Fidelity Certificate

You know yourself to be an honest, trustworthy person, and believe that you will do anything in your power to ensure your lender gets paid back in full. But a lender has no way of knowing your true intentions, and therefore has to assume that you are out to defraud them when crafting the loan documents. This disconnect is resolved through a personal guarantee.

A fidelity certificate only triggers a personal guarantee if the borrower commits fraud, as defined in the loan agreements. Inserting such a clause should be easy for you to agree to—after all, if you can’t promise on paper that you won’t commit fraud, no lender should ever loan money to you!

Limit the Guarantee Time Period

A big risk for the lender occurs at the beginning of your relationship. Both sides are still feeling each other out, and the lender is learning about the nuances in your business that weren’t uncovered through due diligence.

But after a period of time your lender will understand the company’s systems and controls, and will have implemented a monitoring process. Once all this is in place, there may not be an ongoing need for a personal guarantee.

The timing of this shift may vary (anywhere from 6–12 months), and it may be best to stagger the removal of the personal guarantee. For example, after six months of no defaults the personal guarantee could be reduced to 50% of the loan outstanding, after nine months to 25% and after 12 months eliminated entirely.

Use Other Collateral

If you have personal assets, agreeing to an arrangement where cash, stocks, bonds or other assets are placed in a trust account as security could serve to limit the personal guarantee to those specific assets.

Steven Uster is the founder of FundThrough, a marketplace lender that provides secured lines of credit for growing companies. He is also the founder of Zillidy, a personal asset lender that lends against precious metals, diamonds, jewelry, watches and other luxury assets as collateral.

Have you been required to provide a personal guarantee by a lender? How did you deal with the request? Let us know using the comments section below.

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