Understanding the Danger of Personally Guaranteeing Business Debt

You may have seen commercials on television or heard advertisements on the radio about incorporating a business. Incorporation has several disadvantages which include complicated rules and an increase in tax liability. However, it has one very big advantage. When a person incorporates their business the corporation becomes a separate legal entity. All debts incurred by the corporation are collectible only from the corporation. The stockholder, directors, and employees are not personally liable for any of the corporation’s debts or causes of action against the company.

Unfortunately, small corporations just starting out seldom have large amounts of available cash or property that can be used for security, so when the corporation needs money, the owner of the corporation may have to personally guarantee the debt in order to qualify for the loan. In this situation the person who guarantees the debt is called a guarantor. When the guarantor personally guarantees a debt they are telling the lender that if the corporation defaults on the loan the lender can collect from them.

The decision to personally guarantee a debt for a corporation defeats the purpose of incorporating in the first place. It is not uncommon for small business owners who operate a corporation to not realize that the loan documents they signed contain language stating that they personally guarantee the debt. These documents may even require the signer to provide security for the loan in the form of a house, car or financial account. When acting on behalf of a corporation it is important to read the loan documents carefully to be sure that they are not incurring personal liability.