A good friend of mine recently called to discuss a credit limit for a new account. The scenario involved a partnership that had been dissolved. One partner bought out the other, and the now unemployed partner decided to start a competitor company, and he applied to most of his prior company’s creditors for open account terms. He offered to provide an opening Balance Sheet on his new company as well as a personal guarantee.
My friend told me the Balance Sheet showed that the owner had invested enough to pay operating expenses for a couple of months. She told me that a $1 million credit limit had been requested, and that she was trying to decide how much to rely on the personal guarantee being offered.
I responded that personal guarantees have numerous weaknesses. One is that this guarantee relies on the financial strength of the guarantor. Without a personal financial statement, it is impossible to know whether that guarantee is worth the paper it is printed on. Another significant risk is that there is no way of knowing how many guarantees have been signed or will be signed, and every personal guarantee signed reduces the chances that the guarantee my friend was offered would be an effective collection tool. I added that I thought it was exceptionally unlikely that this guarantee was the first and only personal guarantee that would be signed. I encouraged her to:
- Ask her attorney about the enforceability of a personal guarantee in a Community Property state, and
- Arrange for her attorney to draft the guarantee and review any proposed modifications to that guarantee made by the applicant
Personal guarantees are nice to have because they can sometimes be used as leverage to encourage debtors to retire past due balances, but I would be extremely reluctant to base a $1 million decision primarily on any personal guarantee.
What do you think? Does anyone out there feel strongly that PGs are the way to go when dealing with a sub-standard credit risk?
Michael Dennis’ Covering Credit Commentary. Michael’s website is www.coveringcredit.com.
The opinions presented are those of the author. The opinions and recommendations do not necessarily reflect the views of CMA, or their Officers and Directors. Readers are encouraged to evaluate any suggestions or recommendations made, and accept and adopt only those concepts that make sense to them.