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On personal guarantees for loans

January 22, 2006

Q- I want to start a small restaurant and have gone to the bank to help finance the purchase of the necessary equipment and supplies. I am, also, planning on renting a building with a 5 year lease. When I went to the bank they were willing to give me the loan if I had collateral to cover the loan and if I was willing to personally guarantee the entire note. My wife is very unhappy about the personal guaranty as she has to sign off on this as well. This is the only bank that showed any interest in funding this venture. What should I do?

First, please think very carefully about starting a restaurant as this is such a difficult business and the returns are generally very low. It requires many hours, many employees, and fickle customers. Additionally, you are dealing with a very perishable product-food. Of all the businesses that I have assisted, restaurants by far are the most difficult start-up business.

Having a lease for 5 years on a new venture combined with a restaurant is increasing the risk by a factor of 20. If you are unsuccessful in this restaurant and have to close it before 5 years, you will still be legally responsible for the lease payments till the end of the lease.

In terms of the loan, most banks for a new venture are going to require some type of outside of collateral as the probability for failure is so high. A bank works on a very thin margin of between 2 and 3% so they just cannot afford much risk. They must, for the protection of their depositors, reduce their risk through collateral if you are not successful and they know the probability is not good.

Any bank including the Small Business Administration will, also, require a personal guarantee of both the husband and wife for small business loans. What this means is that if the business fails you and your wife will be personally liable for the outstanding debt. There is no question that this added risk of having to make these payments regardless, is something to be seriously considered.

Overall and I am sure you guessed it by now, I would discourage you from this venture as there is just too much risk. You can find other ventures that are less risky with higher returns.