Personal Guarantee

July 23, 2013

July 23, 2013

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A personal guarantee is when one of the owners or principals of a business extends his/her personal credit to back up liabilities incurred by the business such as business loan.  Corporations in the US and most other countries have limited liability for the owners.  That limited liability was an important legal innovation because it allowed large groups […]

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A personal guarantee is when one of the owners or principals of a business extends his/her personal credit to back up liabilities incurred by the business such as business loan.  Corporations in the US and most other countries have limited liability for the owners.  That limited liability was an important legal innovation because it allowed large groups of investors to invest in a company and not risk losing anything more than their original investment.

How likely would you be to buy stock in a company like Microsoft or GE if there was a risk (even a small risk) that you could lose more than you originally invested?  Not likely, which is why limited liability makes a lot of sense for widely held companies.

However, when a business is small, closely held. and doesn’t have an established credit score, other parties are often hesitant to enter into contracts or credit arrangements unless the owner(s) put his/her/their personal credit on the line as well.   For example, the owner of the business could take out a loan in the name of the business, pay himself the proceeds of the loan and then walk away from the business.  It would be difficult for the creditor to get its money back since it would be sheltered by the legal status of the business (they could sue the business and the business owner for fraudulent conveyance, but that would be expensive).

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