Personal Guarantee Isn’t Safe Enough for Investors (article contributed by B)
When an investor considers a crowdfunding platform as an avenue to advance money to a business venture, his primary concern is to secure his capital and earn a respectable return.
Any prudent investor would consider the strengths of the business that is seeking funds before a decision on making a loan through a debt-crowdfunding portal is taken.
But often loan-seekers do not have an adequate financial history and it is difficult to gauge their repayment capacity.
In such cases, the investor may seek to protect the investment that is being made by taking a personal guarantee from the promoter of the business venture.
This approach has severe limitations and in the normal course a personal guarantee does not really protect the lender. If you are planning to lend money based on the comfort that a personal guarantee gives, first consider the following:
- Due diligence of the company
It is useful to remember that you are giving a loan to a business enterprise that will utilise your funds to finance its operations and then return your money with interest.
It follows that you will get your investment back only if the borrowing company performs well in the market and is able to generate the funds to pay you back. Your approach in deciding whether to advance funds or not should be based on this primary consideration.
If the business is in its initial stages and you are unsure if it has a marketable product then it is best to avoid lending it your money. Your decision should be based only on the capacity of the borrower to repay.
Relying on a personal guarantee if the borrower is not credit-worthy, is usually the first step to losing your money.
- Instead of a personal guarantee, seek for collaterals
The ideal way to secure your money is to seek for collaterals from the borrowers. If there is a default on the promised loan payments, the platform could seize the collaterals to recover your losses.
Collateral assets may be of various types. Their purpose is to serve as a second source of loan repayment or a backup for you. A popular form of collateras are invoices. It can also be the business’s inventory or real estate.
As a lender, you would need to make a realistic estimate of the value of the collaterals being offered.
- Borrower may become bankrupt
If a borrower is declared bankrupt, his or her debts are considered to be discharged. In these circumstances, there is little that you can do to recover your money.
Bankruptcy gives the borrower the legal right to deny you any payment. In such an instance, a personal guarantee would be of no use.
In some cases, an unethical promoter may even apply for bankruptcy as a method of avoiding payment.
- A lien on assets will not get discharged with bankruptcy
This is a fine point of difference, but it may become crucially important if the company that you have loaned money to fails. In such a case, you would have a right to approach the individual who had furnished you with a personal guarantee.
Even if that person has filed for bankruptcy you can recover your money if you have a lien on his assets. A bankruptcy only wipes out a personal obligation, it does not eliminate liens.
Hence, the best approach is to insist on collateral instead of a personal guarantee.
- Personal guarantee may have been given to multiple lenders
Even if the individual who has given you a personal guarantee is solvent, you may still not get your dues in case of default by the borrower. This would happen if the assets of the guarantor are less than what is owed to you.
Alternately, the guarantor may have obligations under more than one such personal guarantee. The amount to be recovered could be greatly in excess of the assets that the person owns.
In such a case recovery of your dues would be a complicated and long-drawn out process which may not yield any benefit at all. You cannot control the number of personal guarantees that are issued by the promoter of the business that you have loaned money to.
- A personal guarantee will give you a false sense of security
If the firm that you have loaned money to starts making losses and is unable to repay you, it should galvanize you into action to take all possible steps to get your funds back.
But if you hold a personal guarantee from the promoter you would tend to think that your funds are secure. But this is far from the case. Getting money on the basis of a personal guarantee is a cumbersome and time-consuming process. There is also the possibility that you may not succeed.
A personal guarantee can only serve to provide an additional comfort. It should not be the primary factor in deciding whether to give a loan. A lender who relies on this means to secure a loan is, in a sense, taking the easy way out.
Instead of conducting a deep study of the business that requires funds, a personal guarantee is being taken. But there are no short-cuts to ensuring that you get your money back. If the borrower’s business fails, you could be left empty-handed, holding a piece of worthless paper.
Let’s Crowd Smarter :
The above article is contributed by a crowdfunding investor, B. Thanks, B!
I think the article makes terrific sense. Personal Guarantee should not be a starting point of any analysis. In practice, I always start with the 5C analysis, before looking any other risk mitigating factors, like PG.
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