Regardless of the type of business you operate, extending credit to customers is a significant risk. One way to reduce the probabilities surrounding that risk is to include a personal guarantee in your application for credit. This allows you to hold your customer personally responsible for the amount of money owed, regardless of what happens to their business.
What Is a Personal Guarantee?
A personal guarantee is a simple, written legal statement where a debtor accepts personal responsibility for their company’s debts. This eliminates the separation of the individual from the business entity as far as the debt is concerned. It gives the creditor the ability to attempt collection from either the individual or the business, should they default on the debt.
Why Do Personal Guarantees Work?
The most obvious reason that personal guarantees are effective is that they provide the creditor with more options for collecting the debt. In addition to that, most debtors will place a personal guarantee collection at a higher priority than a standard business debt collection. They will prioritize paying off a debt with a personal guarantee attached compared with a debt that does not have a personal guarantee.
Because debts with personal guarantees are a naturally higher priority for debtors, this makes them more open to communication. There is a stronger personal threat to the debtor, so they have a much greater incentive to work out a deal with you.
Personal guarantees are also an added bonus if you are forced to take your collection to the legal system. Many basic guarantees have been proven to be very effective in obtaining judgments against individuals who accept the responsibility of the loan in question. This ammunition can also work well for you in the hands of a reputable debt collector.
Why Will Debtors Avoid a Personal Guarantee?
One of the primary reasons to incorporate a business is to separate the affairs of that business from the owner’s personal affairs. Committing to signing a personal guarantee goes against that idea, so it is obvious to see that many business owners are not crazy about the idea.
Agreeing to a personal guarantee puts the business owner’s personal assets, like their home, cars, and savings at risk. Many business owners see this as an unnecessary layer of security, especially if their business is on strong financial footing.
What About Alternative Personal Guarantees?
If you have a customer who is dead set against committing to a personal guarantee, you may be able to convince them to agree to an alternative form. This could be a limited personal guarantee that only exposes them to a set dollar amount or percentage of the debt. It could also be a personal guarantee that ends after a certain period of time, or a multi-person guarantee that includes multiple officers of their company.
While your customer may not be thrilled at the idea of offering a personal guarantee on the credit your provide them with, it is a great way to insure yourself with an additional layer of security to protect your business. Simply explain to the customer that it is a guarantee that they are willing to stand behind their business, regardless of what happens in the future.