Small business is the heartbeat of the American economy. Estimates suggest that there are over 33.2 million small businesses in the United States. Combined these businesses account for nearly 99.9% of all American businesses. Most, if not all, of these businesses begin the same way: an idea, a vision, and the need for capital. While the first two are individual in nature, many times the last element requires outside help. Few have the capital necessary to make their vision come to life, so many seek outside financing. This is where the Small Business Association (SBA) enters the picture.
Lenders are often hesitant to grant loans to small businesses due to their risky nature. The SBA guarantees these loans, so that lenders are willing to grant loans to these start-up and small businesses. These guarantees reduce the risk that lenders face in the event of a future default. Essentially, if the business fails, and the loan defaults, the SBA reimburses the lender, so it isn’t left holding the bag. However, there is usually another element of these loans that is often overlooked and misunderstood.
Lenders, and the SBA, require a personal guarantee, especially when there is no collateral to pledge as security from the loan. A personal guarantee provides both the lender, and the SBA, another party to seek repayment from in the event of a default. Essentially, if the small business can’t pay back the loan and defaults, the party granting the personal guarantee becomes wholly liable for the remaining balance on the loan. Even though the lender was reimbursed by the SBA for the default, the SBA is now the party holding the loss. Many times, the lender, on behalf of the SBA, will sue the guarantor of the loan to be compensated and made whole.
Clearly, with the business failure, there is no money to pay back this loan. After all, had the business been successful, the loan would have been paid. Often, I meet with clients wanting to file a business bankruptcy to eliminate the debts of the failed business. The first question I always ask is “did you sign a personal guarantee?” More often than I would like to admit, my clients have no idea. Unfortunately, my clients leave my office looking to file both a business bankruptcy AND a personal bankruptcy to eliminate the debt of the failed business.
The moral of this story… ask questions when starting a business. Understand the documents you are signing. Understand the risk you are taking with this business. But, if you find yourself in this situation, you have options. Please reach out to a bankruptcy attorney to discuss those options.