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Personal guarantees: should you sign?
Forming a corporation or a limited liability company is one of the smartest things you can do to protect your personal assets. In general, if a company can’t pay its bills, its creditors can’t force the company’s owner to pay its bills — unless the company’s owner has signed a personal guarantee.
Signing a personal guarantee is like co-signing a business loan. A personal guarantee is a legally binding promise to repay a business debt from your own personal funds if your company is unable to pay it. Signing a personal guarantee means that, when it comes to the creditor on the guarantee, you cannot rely on the fact that your business is an LLC or a corporation to avoid paying that creditor. In some ways, a personal guarantee undoes the protections that you put in place when you set up your business as a corporation or an LLC.
If your business defaults on a loan that you personally guaranteed, your personal assets may be at risk. A creditor can sue you personally for the company’s outstanding debt. If you lose, the court can enter judgment against you personally, and your bank accounts — even joint accounts — may be levied, your wages may be garnished and your property may be seized. Retirement accounts, Social Security income and disability income are usually safe, but other assets are not.
A personal guarantee is so risky, you may wonder why any small business owner would sign one. The answer is simple: many lenders require them. Lenders understand the risks of doing business with a corporation or LLC, so they often require one or more of the major shareholders in a business to personally guarantee a loan, a line of credit or charge account. Small business owners have no choice but to sign a personal guarantee if they need to borrow operating capital or order inventory or other goods on credit.
Small business owners should understand the risks of signing a personal guarantee and make an informed decision before signing. A personal guarantee may be unavoidable if a business owner needs to buy goods or services on credit.
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