When buying a business, the business seller or landlord of the premises may ask you to provide a personal guarantee in the contract of sale or lease. Providing a personal guarantee could put your personal assets at risk, so it is important to understand how it works. This article explains what a personal guarantee is, why it is used and what to consider if you are required to provide one.
How a Personal Guarantee Works
A personal guarantee is a responsibility that an individual takes on to guarantee the obligations of another individual or entity. For example, if your company is buying another business, your company director may provide a personal guarantee in the sale contract. The director becomes a guarantor. If the company cannot pay the purchase price or meet a contractual obligation, the director must meet that obligation themselves.
When a business is sold, the seller’s lease is often transferred to the buyer. Alternatively, the buyer enters into a new lease with the landlord. If the landlord requires a personal guarantee from the buyer, it works the same way as in the contract of sale. For example, if the buyer company is unable to pay rent, the guarantor under the lease would be responsible for making those rent payments.
Features of a Personal Guarantee
The personal guarantee will be set out as a provision in the sale or lease contract. The provision will generally state that the:
- guarantor guarantees to the seller the performance of the buyer’s obligations under the contract;
- guarantor indemnifies the seller against losses it suffers as a result of the buyer’s breach of its obligations; and
- guarantee is continuing and is not affected by particular actions of the seller (such as the seller giving the buyer more time to make payment).
Every personal guarantee provision is different. Some may be brief and reasonable. Others can be extensive, cumbersome and confer additional obligations or rights on either party. For example, some personal guarantee provisions may allow the seller to pursue the guarantor to pay the purchase price before taking any action against the buyer. It is best to seek advice from a business sale lawyer to ensure you understand your responsibilities.
Consequences of Signing a Guarantee
By providing a personal guarantee, you personally bear the risk of the transaction along with the transacting entity (e.g. your company). So if the buyer does not pay the purchase price, the seller may initiate legal proceedings against you as guarantor. If you do not have the cash to pay the seller, the seller may go after your personal assets.
You may find your role as guarantor also has flow-on financial effects. For example, it may be more difficult for you to obtain finance from a bank. This is because your personal assets are already at risk under the guarantee.
Whether or not you provide a personal guarantee ultimately comes down to the:
- importance of the guarantee to both parties;
- willingness of the buyer and guarantor to take on that extra risk; and
- bargaining power of each party.
It is generally not advisable to provide a personal guarantee when buying a business. But in some cases, you may find that you do not have enough negotiating power to remove the guarantee provision. If you do decide to make a personal guarantee, know exactly what you are agreeing to. Often, you are not guaranteeing only the principal amount, but also additional sums, including interest and fees.
By agreeing to provide a personal guarantee, you take on a personal risk. Ensure you consider the potential consequences on your business and personal life. If a seller or landlord insists on a guarantee before proceeding with a transaction, obtain legal advice so you understand your rights and responsibilities. A business sale lawyer can also help ensure the clauses in the contract or lease are reasonable.
Call LegalVision’s experienced business purchase lawyers today on 1300 544 755 or fill out the form on this page to see how we can assist.
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