Banks and landlords often ask founders to guarantee company debts personally. For a young company with little credit history, a guarantee may be the only way to obtain a loan or an office, and I understand why founders agree to give one. It is important to remember, however, that a guarantee sits outside the protection of limited liability, so if the company does not pay, the creditor can pursue the founder's personal assets under the terms of the guarantee.
For that reason, the guarantee should always be read together with the loan or lease it supports, including any clause that allows the facility to be changed later. The limit and the demand terms show how much the founder could be asked to pay and when, while the release terms show how the guarantee comes to an end, and these questions become even more important if the founder leaves the company before the debt is repaid.
What you are actually promising
A guarantee is a promise to pay if the company does not. An indemnity is a separate promise to cover the creditor's loss, and it can remain effective even where the guarantee itself fails. Bank documents usually contain both, so they should be read together to understand every route the lender has to recover from the founder.
It is also important to check which borrowers and which facilities the guarantee covers. Wording that covers "all monies" can extend to future loans the founder knows nothing about today and to the debts of other group companies, and it may even cover debts the lender buys from someone else. The founder should also check whether a new lender can enforce the guarantee if the loan is sold.
The guarantee must be validly made and signed under its governing law. If a founder is asked to sign after the money has already been lent, they should take advice before signing, because whether the guarantee is enforceable can depend on how and when it was made.
Work out the maximum exposure
The cap on the guarantee should be read together with the provisions on interest and enforcement costs. If the cap only covers the principal amount, the real exposure can be much higher, so it is worth asking for a worked example based on a long default to see the full figure.
Where several founders sign, they should check whether their liability is joint and several. If it is, the lender can claim the whole amount from whichever founder is easiest to reach, and although a contribution agreement between the founders allows the one who pays to recover a share from the others, that is only helpful if the others can actually pay.
For a continuing facility, the founder should check whether new borrowing increases their exposure and whether the cap applies across the whole relationship with the lender. Copies of all the documents the guarantee refers to should be requested and kept.
When the lender can demand payment
Some guarantees require the lender to pursue the company or its security before turning to the guarantor, but most bank guarantees do not. They allow the lender to demand payment from the guarantor as soon as the company defaults, so the demand and notice clauses should be read carefully, including how long the guarantor has to pay.
Waiver clauses list the things the lender can do without releasing the guarantor, such as giving the company more time to pay or releasing other security. In effect, the guarantor agrees in advance to changes they have not yet seen, so those permissions should be read together with the cap.
A reinstatement clause means that if a payment to the lender is later reversed, for example in the company's liquidation, the guarantee comes back into effect. This should be dealt with when the founder negotiates the terms of any release.
What you can recover after paying
A guarantor who pays the lender usually has a right to recover the money from the company and a contribution from any co‑guarantors. Many guarantees postpone those rights until the lender has been paid in full, and prevent the guarantor from taking security or claiming in the company's insolvency, so the founder should understand what they are giving up.
A right to be repaid by the company is only worth something if the company is able to pay. If the company has failed, the founder may recover very little, and that possible personal loss should be weighed before the guarantee is signed.
If the founder is also giving personal security, such as a mortgage over their home, the title and any existing charges should be checked, and a spouse or co‑owner should receive independent advice before agreeing to it.
Get advice on your own position
The company's lawyers act for the company, and the founder's personal exposure is usually outside the scope of their instructions, so the founder should take their own advice. The adviser will need the guarantee and the facility documents, including any later documents that change the debt.
It is also worth asking the lender whether it will accept a cap linked to a specific facility or amount. Even if the lender refuses, the founder should understand exactly what they are agreeing to before deciding whether to sign.
The company still needs its own approvals for the borrowing and for any security it gives, and those procedures are separate from the founder's personal decision. I explain them in who is allowed to sign for the company.
Get released when you leave
Leaving the board or selling shares does not end a personal guarantee unless the guarantee says so or the creditor agrees to release the founder. If another founder promises in an exit agreement to take over the guarantee, that promise binds them, but the lender can still pursue the founder who signed the guarantee.
The termination terms of a continuing guarantee should also be checked, since ending the guarantee may stop it covering future loans while leaving the founder liable for existing ones. The founder should obtain written confirmation from the creditor of exactly what is being released, including contingent claims and the risk of reinstatement, and the same release is needed when the company closes, as I explain in closing a startup and settling what remains.
This article is general information and not legal advice. For guidance on your specific circumstances, speak with us directly.