When it comes to making a personal business guarantee, Will Beckett has one piece of advice: Don't do it.
The co-founder of the London-based steakhouse company Hawksmoor built the $50-million-a-year restaurant empire without ever putting personal assets on the line. But it was an easier decision for Beckett than other entrepreneurs.
"We didn't guarantee personal assets, because we had none," Beckett said of starting out with several money-losing restaurants at age 26 in 2003 with his best friend, Huw Gott, before striking gold with the Hawksmoor concept. "In retrospect, that was a blessing. I would never now put my family's security on the line to make more money. I used to draw no distinction between my finances and the company's finances. Now I have a very clear line between the two."
Beckett's advice comes at a time when financing has tightened for entrepreneurs. Now to get a loan for an early stage or risky venture, banks often require applicants to make a personal guarantee, or a vow to repay funds with personal cash and/or assets in case of default. The arrangement can be tempting for everyone from restaurateurs to online entrepreneurs, but is risky for borrowers who may be required to put up their primary residences or life savings as collateral. Most entrepreneurs and experts agree that betting the house should be a last resort.
Here are a few ways to protect your personal assets when starting any business.
Shailesh Kumar, who now runs a financial advisory site, ValueStockGuide.com, was working with two banks in 2008 to recapitalize his steel-service center business when he was asked to put up his primary residence as collateral, despite having more than enough equipment and inventory to cover it.
Luckily, he'd already set up a holding company for all the steel service centers and other lines of business he owned as individual entities. This way, he owned equity directly in the top-level holding company but not the individual entities. The move cost him $500 using a company incorporation service and protected hundreds of thousands in personal assets when in 2009 he was forced to liquidate the steel business when the manufacturing sector took a tumble.
"I satisfied the debt holders by turning over the collateral in the business that supported the debt, but we also owed money to many of our suppliers that we could not pay," he said. "We had many tense meetings with the suppliers, with them trying to threaten action against my personal assets, but the two layers of corporate veil I had in place stood the test in courts. I was able to get debt written off, and there was no impact on the personal assets at all."
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The best way to save your personal assets is not to offer them up at all.
"Find a lender who will accept an obligation limited to [a corporate] entity without a personal guarantee," said Phil Crowley of New Jersey-based Law Office of Philip P. Crowley. "Creative solutions also involve using loans [including from friends and family] that are obligations only of the entity and are convertible into equity in the legal entity subject to certain conditions."
To do this correctly, hire a lawyer with this specialized experience to set up the paperwork, Crowley said.
When signing documents on behalf of the business, be sure to put the entity's name alongside it so it is clear you are acting as the entity and not as an individual, he said.
Banks aren't the only ones that may request a personal guarantee. Commercial lessors often do, too, and they may have the ability to sue for the remaining term of the lease if things go south. Consider negotiating with the landlord to limit the term of your personal guarantee.
"For example, on a five-year lease, ask for what's called a burn-off, where your personal guarantee will expire, say, after 2.5 years," said Kerry T. Boyle, a partner at the Ohio law firm Isaac Wiles.
Ask for the ability to terminate the lease if sales are lower than forecasted, Boyle said, otherwise known as a "gross sales kickout."
Alternatively, if sales aren't solid, you can ask the landlord to allow you to pay a percentage of gross sales instead of the stated rent amount, limiting your financial liability a little.
Ask yourself: Do you really need that bank loan or whatever it is you want to buy?
"Many times, entrepreneurs will have preconceived notions about what is 'required' to be successful in a certain industry," said John Weninger of the Wisconsin-based Vision Wealth Partners, which advises small businesses. "A lot of times those ideas are floated by people who stand to make a buck selling their product or service to gullible entrepreneurs who just don't know."
Consider all of the free, rentable or lower-cost tools that can be used to boost a new business before borrowing a large sum or hiring people, he said. Purchasing a business address is cheap and offers credibility while working out of a home office, while strategic partnerships can offer free yet valuable resources. "Consider approaching existing businesses who may be able to [share] space, resources … that is of little or no cost to you," Weninger said. Hire interns through a college program instead of employees to keep labor expenses low, he added.
Hawksmoor is expanding to the United States with a restaurant in New York City's World Trade Center set to open later this year. They financed the WTC restaurant with their current revenue and investor funding. The co-founders now have the luxury of being able to finance expansion based on the value in the business and its cash flow. But Beckett sees several restaurant entrepreneurs spending very large amounts of their personal wealth to keep up in the competitive dining environment, and it reminds him of when they started their first restaurant on a shoestring.
"It's a real source of concern for me," Beckett said. "What is it you are signing away if this goes wrong?"
- Never pledge personal assets to finance the start of a new business.
- Use a legal structure that keeps personal assets and business assets separate.
- Forming a holding company and some commercial lease provisions offer protections.
- Consider other options if a bank or commercial landlord wants personal assets pledged.