Learn what a personal guarantee for a small business loan is and what it means to you and your business. You may not need to sign a personal guarantee for a business loan – or at the very least you may be able to mitigate the risk.
- David Nayor, Co-President and Chief Operating Officer, BoeFly.com
- Jon Cosentino, General Manager, Commercial Capital Training Group
- Randy Evans, Attorney, Monroe Moxness Berg PA
- James Coughlin, Chief Underwriting Officer, Asterisk Financial Group
- Casper Zublin, President and COO, IRP
Understanding The Personal Guarantee On A Business Loan – Recorded Webinar
Transcript of Personal Guarantees For Business Loans Webinar
David Nayor: Good afternoon. For those of you that just joined, this is David Nayor from Boefly. We’re just going to wait another minute for everyone to log in. We’ve got a large number of attendees today. They’re just logging in. Several of you are just still logging in. We’re just going to wait one more minute and then we’ll start the webinar. Thanks.
Good afternoon. Hello everyone and thank you for joining the webinar. This is Personal Guarantees 101. We’ve got a great group of panelists today. But before we start our session today I’d like to ask Beth Soloman, who is the Vice President of Strategic Initiatives and Industry Relations at the International Franchise Association and a great friend of Boefly to say a couple words to kick us off. Beth?
Beth Soloman: Perfect. Thank you so much David and welcome everybody. Thank you for being here today. This webinar is part of our ongoing capital access campaign. We have a strategic alliance partner, Boefly who, as you know, has done a tremendous job to extend and enhance credit access to these in franchising. Part of our strategic alliance Boefly is presenting in concert with IFA various content of tools and solutions to help crack the credit box. And today’s edition is on personal guarantees. Boefly has lined up an excellent panel. So we very much appreciate your participation and we hope that it’s a very successful session. And we will be doing more webinars throughout the fall as we continue to try to solve this challenge for the industry. So thank you very much, David.
David Nayor: Thanks, Beth, for those kind words. We appreciate the IFA’s leadership in keeping the importance of credit access on everyone’s radar screen. You’ve been doing a great job. All of us at Boefly – we really appreciate our alliance with the IFA and look forward to continuing our work together.
Again, this is David Nayor, of Boefly, the online marketplace that connects business owners seeking financing with a network of more than 2,200 lenders. I’d like to start by giving a special welcome to our Boefly members, to our more than 125 franchise branch from all sectors. All of our lenders, and those professional loan brokers who rely on Boefly to help their clients. And most of all, the borrowers that we’re all helping – the borrowers who use Boefly to obtain financing. We’re proud to have you as clients and happy to build this program for you.
A quick housekeeping item; this session will be recorded and we’ll send an email out with a link to the recording. So don’t worry if you miss something, we’ll have that for you. You can submit questions throughout our call and we’ll handle them at the end of the program. Also, to gain some insights from our attendees, and we had over 250 registrations for this topic today, we’ll be asking you to respond to poll questions throughout the session.
Now on to the panelists. I’d like to introduce the panelists on today’s session. We’re joined today by Jon Cosentino, who is a professional loan broker and the General Manager of Commercial Capital Training group, a source of training for hundreds of loan brokers. We’re also joined by Casper Zublin, a business owner who is the CEO of IRP. Randy Evans, who is an attorney with Monroe, Moxness, and Berg. And James Coughlin¸who’s the Chief Underwriting Officer at Asterisk Financial. You can find bios – we have a URL on the screen – for all of our panelists. But we’re going to get right into – right into the session but you can find their bios online.
One last housekeeping item; I strongly encourage you to submit questions throughout the session. We’ll look to incorporate them, if we can, during the call or at the end of the call. So, first poll question – we’ll kick it off with a poll question to our audience today, just so we can get an understanding of who has joined. Just give a quick classification as a business owner or franchisee, franchise, or lender, or other and we’ll just keep this screen up for a couple of sessions and then we’ll start with the panel discussion.
Okay, we’ll give it another couple of seconds and we’ll show you the results just so everyone can see. Good. We’ve got a really good mix today: 16 percent business owners, 15 percent – I’m sorry, 16 percent franchisees, 15 percent independent business owners, 22 percent franchisors, and 12 percent of lenders, 35 of other. So great. This will make for an interesting discussion today.
So let’s kick off our discussion with Jon Cosentino. So Jon, you’re a former banker and currently a professional loan broker. You’re also the General Manager at Commercial Capital Training group. And you’ve trained hundreds of professional loan brokers. So this will be good to kick it off with you. And before we get into some of the complex issues of PGs, let’s start with some of the basics. When you’re training your students, how do you define a personal guarantee, or as we in the industry like to refer as PGs.
Jon Cosentino: Thanks Dave. First off, I’d like to say thanks for having us a part of this. We’re big fans of your platform and as you know we’ve had a number of success stories associated with Boefly and we’re proud to be part of it and hopefully will continue to be so. You know, I guess simply put I see a personal guarantee is it makes one personally liable for the debt of a borrower. It’s most commonly associated with one’s business. However, it can be required of a third party debt where perhaps a personal guarantor may be required by a lender to add more strength to a deal.
Typically that guarantor will have a strong net worth and good liquidities. As a personal guarantor your personal assets may be subject to claim by the lender in the event that the borrower defaults on the loan. Generally a lender will attempt to go after the assets of the borrowing entity prior to pursuing the personal guarantor’s assets and if there’s a shortfall after liquidation of those assets, then the personal guarantor’s assets may be liquidated. And those can include, unfortunately, one’s home in some states, savings, whatever other assets you may have. My experience on the lending side is generally lenders will pursue the borrowing assets first and then go after the business assets, that leaves the guarantor’s assets afterward.
But we may be addressing this from a legal side rather than – I suppose there are certain circumstances where the lender can take the path of least resistance, or the lowest hanging fruit, and actually go after the guarantors assets without the other.
David Nayor: Sure. And from a borrower’s perspective, let’s assume that most borrowers would prefer not to put up a personal guarantee. Are there certain loan products that may not require a PG and others that regularly do?
Jon Cosentino: Well in today’s world, most do. My experience is kind of three separate areas where I see situations where a guarantor may not be required. One of them is on the equipment leasing front where you may have a large corporation where you have – it could be publicly traded – where you may have a large corporation where the ownership is diluted to the point where there really isn’t an individual ownership that represents enough significance to make that guarantee worthwhile, or you’ve got an A rated credit with a strong cash flow, perhaps the loan amount is relatively insignificant to the balance sheet of the corporate guarantor. We call that corp-only in the equipment leasing world, so it’s basically relying only on the guarantee of the company and not the others.
David Nayor: Sure. And –
Jon Cosentino: I’m sorry, go ahead.
David Nayor: Yeah, I was just going to say does it come down to an industry – on the business side are there certain industries that may or may not play a role?
Jon Cosentino: I can’t say I line it up to a specific industry more. Just to the corporation size, you know, time in business, strength of the balance sheets. So it really could be in any asset class. But it’s more a function of the strength of the corporate entity I think more than anything else.
Another area that we see non-guaranteed loans – and in that arena we call that recourse, nonrecourse means no guarantee. – and that’s typically in the investment real estate arena where the lender is really relying on the asset itself, which is the collateral, the pledge is real property or investment real estate. And in those cases the ownership, or the sponsor we call them, are typically not help personally liable.
In those cases the lender will generally lend the loan to value ration such that they’re kind of over-collateralized, if you will. We’re talking 50, 60, 65 percent loan to value. So in theory there’s enough excess collateral there that they don’t need to rely on the guarantor. And also they’re really relying more on the asset itself; what type of cash flow it has, who the tenants are if it’s a multi-tenant situation.
And I think the third situation where I see it is what we call single-tenant, triple-net leases. And that basically is a situation where you have one tenant in a building, that tenant is usually a national franchise, corporate owned or a large company where the strength of that tenant and the lease of that tenant really has the value more so than the collateral itself. It’s kind of more of a cash flow lending scenario. In those cases we really rely on the tenant and the tenant’s financial history and strength and not that of the owner of the property. I think that ____ [Crosstalk] are the ones where we see it.
David Nayor: Got it. Great. So that clarifies a lot of us. And do you think that we’ve seen a change in the way that PGs are used since the credit crisis? Has that – has that tightened up like lending has in general?
Jon Cosentino: Definitely. It’s the standard now to have it, with the exception of the three things that we things we discussed. Anytime – In my experience anytime you’ve got a business owner in what we call the small to medium sized businesses, generally my experience is that the bank or whomever the lender is — is going to require a guarantee from the owners of that company.
David Nayor: Okay. Okay good. So now that we’ve got our footing I want to shift gears and hear directly from a business owner. We’re joined by Casper Zublin, who is CEO of IRP. And just to start off, by way of background, what is your company do, Casper?
Casper Zublin: We’re a rubber products manufacturer, mainly for the medical industry.
David Nayor: Okay. And how long has your company been operating?
Casper Zublin: Thirteen years.
David Nayor: Okay. Great. So plenty of experience as a business owner. And I understand that you’ve owned several other business in the past. Tell us about your experience with personal guarantees. Have you ever had to sign one?
Casper Zublin: Twenty five years I’ve had a personal guarantee and sometimes multiple personal guarantees. And so I am very familiar with signing them.
David Nayor: So a big – a couple of decades of your life you’ve personally guaranteed loans. Can you think of a time in which you were genuinely concerned that a PG was going to come into effect? That the bank was going to rely on you PG to meet – to meet your debt obligations?
Casper Zublin: I can tell you I’ve lost a lot of sleepless nights over PGs. I couldn’t tell you how many nights I’ve lost but I ___. There was one time where things were pretty bad. And they were bad enough where I had to sit down and talk to my wife about it. And, you know, that if things continued in this direction that we would lose everything. The assets of the business to cover the loans, it was a lot of loans. A lot of hard work over the years was at risk. And most likely the bank would take our investment accounts and our house.
And when I kind of tallied everything up, in the middle of the night one night, there wasn’t anything left over. And things were bad enough that it was time to say, “Sugar.” And candidly, that was probably one of the worst days of my life. I sat ___ kitchen [break in audio] and told her that, you know, I’m not sure it’s going to happen, but it is certainly a potential. So yeah, I’ve had some rough days.
David Nayor: So when you think back to that crisis situation or, you know, if you’ve had a couple of them. Because of the PG in place, do you think it could have played out differently if you didn’t have a PG in place? Would the business have been run the same or differently? Tell us your thoughts about that.
Casper Zublin: I think the short answer is yes. I don’t know how business owners react under kind of extreme personal stress. ____ ___ [break in audio] but I think ____ [break in audio] decisions more timely, I think I would have probably had better decision making, I would have been able to see situations more clearly. But that – I found myself chasing my tail, if I may. When you have this kind of extreme personal stress on top of the business. And on one level I’m sure if I’m a banker and a lender – maybe they love the fact that I’m so wrapped around the axel – but candidly, I think decision making suffers in that situation.
Would I have made different decisions? No, but I would have gotten to those decisions faster, easier – I think a whole lot easier, a whole lot faster. I could have focused, I think, on the team at the business without this thought of, “I got everything on the line here guys.” Most of the team at the business didn’t have everything on the line. They could go find another job. For me it was pretty much a wipeout. I think there’s some real issues there.
David Nayor: So – and you eluded to this – if you were a banker and – let’s role reverse for a minute – would you require your borrowers to give a PG in light of the stress that you’ve mentioned, that it places on that borrower?
Casper Zublin: Yeah, I don’t know if that’s a fair question. Look, I think PGs have a place in the lending world. I think the validity of a PG is that – look, I have several companies. I can move assets from one pocket to the next pocket. If I borrow on one pocket and things aren’t prosperous across the board, if I’m a lender I’ve really made an unsecured loan, right? So the personal guarantee, if I kind of take a step back, on a technical basis really serves a purpose to cross-collateralize and to make sure that I have the attention of the business owner.
So do I understand it when I take a step back? Absolutely. Would I – if I was making a loan would I ask for a personal guarantee? Yeah, probably. I think that’s a fact of life and I think business has become fairly sophisticated and business men are fairly sophisticated. And we all went what you’re former speaker said, a nonrecourse loan. But they’re hard to find, they’re difficult to get. I think with the latest credit crisis, you know, on a personal basis, I’ve gotten two loans in the last couple – in the last 12 months. One for about three million dollars and the other one – I actually just got approval yesterday for another million dollars on an equipment term loan.
And I know lots of banks – we put it out to bid – not one came back – we’re a very healthy balance sheet, good cash flow company. Not one came back without the PG. And we went through the negotiations and we tried to negotiate it down to a pro-rata based on performance, I think we tried it a dozen different ways and it was ____, 100 percent PG, no negotiation otherwise I could take my business elsewhere. So – not a factor –
David Nayor: That’s interesting. Well first congratulations on the loan that you just got. Good news for our audience, there is credit out there. But also interesting that there wasn’t much negotiation on the PG, which before we move to our – our next panelist – which this is a nice parlay into our next panelist – I want to push out a pulling question. And thank you, Casper, for your words on – from the borrower’s perspective.
From the audience, borrowers, and brokers, franchisees, non-franchisee borrowers, have you ever signed a PG? Simply a yes or no, just want to get an idea of who out there has had the experience of a PG. We’ll leave this up for the next five to ten seconds and then we’ll release the results. So lenders, obviously, you’re on the other side of the coin. Unless you’ve owned a business you can go ahead and answer this question as well.
Okay. So we’ve got a fair amount of people on the call, about half signed a personal guarantee. And about half of that who have not. So let’s shift now to consider some advice from – for business owners to think about as it relates to personal guarantees. Randy, you’re a lawyer with Monroe, Moxness, and Berg. You concentrate on corporate finance, and mergers and acquisitions, as well as franchise law. Before we discuss advice in negotiating, are there any alternatives that the business owners can look to in the place of a PG?
Randy Evans: Yes, thanks David. And yes there are. I think there are a couple of primary alternatives that I would mention. One is, and I’ve seen this work in a number of situations, where there’s an opportunity for the business owner to bring in, generally not a replacement guarantor, but an additional guarantor that can provide some additional level of coverage for the lender and obviously share the rest with the business owner. It’s not a bad option other than the additional – the person putting up their guarantee generally is going to want some form of compensation for the risk that they’re taking. Obviously it might depend on whether they’re involved in the business or not involved in the business.
But typically that takes the form of either some sort of guarantee fee, like an annual – an annual payment based on some percentage of the loan amount that’s guaranteed, or in some cases it may actually take the form of an equity interest in the business. So while it’s not a bad alternative if you have someone in your business circle who is willing to do it. The down side is obviously that it costs money, or potentially upside in terms of your equity interest in your business in order to do it. What that cost is, obviously, is negotiable and varies from person to person.
But I think it’s safe to say if someone is going to come in and put a personal guarantee in place on your behalf, you’re probably looking at somewhere in the neighborhood of 5 to 10 percent of the loan amount on an annual basis. It’s obviously coming down as the loan comes down, or the equity piece is completely negotiable.
The other option that I see more frequently in my practice is to put up some other form of credit enhancement to the lender in place of the personal guarantee. And the one that seems to be – and this can take a lot of different forms obviously. It could be pledging some other piece of collateral or whatever. But the one that seems to be maybe the most prevalent right now, in this market, is to use a letter of credit. We’ve had a number of transactions, finance transactions, over the last three or four years where clients have been successful in using a letter of credit for some defined amount of money over some defined period of time as a way to at least put some limits around the exposure. As opposed to what Casper referred to, which is kind of the standard joint and several unlimited guarantee. So I think that’s something that people can keep in mind. Ten years ago I didn’t see this very much, but in the last four or five years we’ve really started to see this become a real option to personal guarantees.
The other option, I guess, it’s not really an alternative – and I know we’re going to talk about this more later in the webinar – personal guarantee insurance, while not an alternative to the guarantee obviously is a way to minimize the risk. So I think that’s definitely something to take a look at as well.
David Nayor: Okay. Great. And what about negotiating the PG over the course of the loan? Have you seen that happen where a company can come back and say, “Hey, look where we are now?” Have you seen a company ever negotiate down the road from the origination of the loan?
Randy Evans: I have seen that happen but I would say fairly infrequently. I think it’s certainly better practice to negotiate those limits, negotiate release provisions etcetera, on the front end, as opposed to coming back and trying to do those midstream. On the other hand, if you – if the business really performs better than everyone expected when the loan was made, circumstances change, etcetera – yeah certainly there are opportunities to come back sort of midstream and have a conversation with the lender about, again, reducing or potentially releasing that guarantee.
David Nayor: Okay good. And switching to the – kind of thinking from the bank’s side, how common – how have you seen that the personal guarantee will be called from the bank? Does it happen frequently?
Randy Evans: You know, in my experience that really has not happened that frequently. And unfortunately, my experience is going on thirty years, so it’s been a while. I have not really encountered that many situations where the lender actually has called a guarantee or has litigated a guarantee, for example. I think, in my experience, I think – I don’t know if Casper would agree with this from his personal experience of signing these personal guarantees — but my experience has been – and I also represent lenders, and so I — I’ve had this discussion with lender clients as well – I think most personal guarantees are really for what I call behavior modification purposes more so than for actual financial recovery from the guarantor.
The – you know, from the lender’s perspective it’s not – I mean part of the idea is that they have another pocket that they can look to in a default scenario, but more so I think it’s to make sure that the business owner has some skin in the game and when things go south and you have a situation like Casper described, that what he – he turned that situation around and was able to successfully resolve, to everybody’s benefit, a bad situation. If you don’t have skin in the game and there’s really nothing to lose, what the lender is afraid of is that you’re just going to toss them the keys and walk away. So I think that’s why personal guarantees are so universally required, but not necessarily enforced in the sense of really going after the guarantor, and getting a judgment, and attaching personal assets, and so forth.
David Nayor: That’s a good point. And if you’ve been in any kind of a liquidation scenario or a bank has called the guarantee, how have you seen the bank react to that? Are they going after the business assets first and then calling on the guarantee? Is there an ordering of – that the PG falls in for a bank? What’s been your experience?
Randy Evans: Yeah, well that – and that gets into, I guess, a couple of points that I did want to cover in terms of negotiating. When you sit down as a business owner to try to negotiate the guarantee with the lender – I mean Casper mentioned the idea of limiting the amount of the guarantee and I think that’s – obviously that’s a good place to start. And, I guess – sort of tying back to my prior comment, I think that’s a point where as a business owner you can make the point, and particularly we do a lot of work in the franchise – with franchise clients and I know there are a number of franchise owners on this – on this call.
That’s where I think you can point out to the lender that you do have skin in the game. And it’s not just limited to the – to the guarantee that you’re providing with the loan. You also have, in many cases, guarantees to the franchisor, you have personal guarantees to some or all of your landlords, you may have personal guarantees to other vendors to the business, etcetera.
So my approach on the amount is generally to say – the guarantee is only worth – if you accept my premise that the guarantee is more for behavior modification than it is for true financial recovery, there – the guarantee is only worth what it’s worth. And to the extent that I have other guarantees to other constituents that are critical to the operation of my business, I have all the skin in the game I could possibly have. I think the story Casper related, I don’t think he would say that he wasn’t incentivized to save the company. So that – I think that’s a way to try to bring some reality to the situation and try to limit the – from a scope perspective – limit the amount of the exposure.
To your specific question about, I guess, recovery and how the bank or the lender would go about doing that, I mean that sort of gets into not just the joint and several versus pro-rata issue that I think either Jon or Casper mentioned earlier, but also sort of how the guarantee works. Not to get into too much legalese, but there is a difference between a payment guarantee and a performance guarantee. And most guarantees that you’re going to see from a bank are going to be a payment guarantee.
And what that means, legally, is that you are essentially a direct obligor on the loan. You are basically a co-borrower. And the bank has the right to seek to recover under your guarantee regardless of whether they’ve sued the borrower or liquidated their collateral. I always try to push for performance guarantee which would require the bank to first exhaust all of their legal remedies against the company, the primary borrower, and any collateral assets that they have. And then come and knock on my door as the guarantor for the deficiency. ‘Cause my guarantee is supposed to be a back-up to the company, not – if I’m going to be a primary obligor then I may as well sign the loan.
David Nayor: Yeah that’s a good point on – a performance versus a payment guarantee. And it may come down to certain products. Do you see performance guarantees more prevalent in certain loan products or things like factoring versus a payment guarantee in a traditional debt structure?
Randy Evans: Yeah, you know I’m not as familiar with the factoring to be perfectly honest. I don’t know how the guarantees work there. I think in the context of sort of general commercial lending and franchise finance which is where I’m more familiar, it really depends on – my experience is it depends on the lender and it depends on the circumstance. But lenders don’t like the idea of a performance guarantee because they obviously want – they don’t want – they want as much flexibility as possible in terms of recovering in a default. But that said, it’s certainly not uncommon to negotiate those kinds of provisions.
David Nayor: Great. Well excellent. Thanks Randy.
Randy Evans: Yeah, could I – I’m sorry, David. Could I just mention two other things quickly in terms of negotiating? And I apologize, but just a couple other points that occurred to me. One is – the other thing that we see very frequently besides some kind of limit on the amount of the guarantee are what we call burn-off provisions. And these are very, very common, at least in my practice. And what I mean by burn-off is that the guarantee will either be reduced or released based on some event occurring in the future; whether that’s just the passage of some period of time, or the loan being paid down by some amount or some percentage, or the business achieving some sort of predetermined financial threshold, that you get your leverage down to a certain level or achieve a certain level of profitability or, whatever the metric is.
The theory behind it being – however you structure that – as the business performs better or the loan is reduced, there’s less risk and should be less need for a personal guarantee. So I think those are provisions to definitely keep in mind because they’re pretty commonly used and I think banks are generally are fairly comfortable with the concept of either a reduction, more so a reduction than a release, based on those kind of objective criteria.
David Nayor: Great. Thank you for that. So let’s — let’s assume that the bar had done what they can do to limit the PG. And Randy, those suggestions on negotiation are – negotiating the PG are great. Some of those things borrowers may not have thought of. So for those of you on the line, again, we’ll have this recorded so you’ll be able to pick up those negotiating strategies. But what if the bar is still anxious about the PG? James Coughlin of Asterisk Financial has a really innovative insurance product. Some of you have heard about it. Some of you may not have. But it’s called personal guarantee insurance. Jim, why don’t you just give us an overview on PGI so we can kind of get our bearings.
James Coughlin: Oh thank you. Personal guarantee insurance was developed specifically to address that anxiety or worry that business owners have and that the lender will pursue them for deficiencies. And the product is available for catastrophic loss. When that business owner is pursued for the deficiency. It covers that net liability in a meaningful way; 30 to 70 percent coverage is available for that product. But it helps them get access to capital that wouldn’t ordinarily be there.
And I think in our prior conversation today they talked about the lenders don’t aggressively pursue some of the guarantors. And that’s very true, partially because the value of the guarantee has diminished over time. Because when a business is in trouble, many times that business owner has invested not only all of their time, but all of their capital and personal net worth into it. This would give them the ability to actually come out fighting at the end of it, being able to support that with some access to capital.
David Nayor: Great. And what is the – what is personal – what is the insurance typically cover, what percentage of the insured net liability?
James Coughlin: It is at the business owner’s option between 30 and 70 percent of the risk that they’re signing up for. So on a million dollar loan if you sign up for 50 percent guarantee, you’re only on the hook for 500,000. You can buy 50 percent coverage of that which would be 250,000. So it is at their discretion between 30 and 70. We find that more risk-adverse borrowers, people who have more at risk or don’t tolerate the risk, buy between 50 and 70 percent coverage. And those who are very confident in the circumstances that understand that there is some risk to them personally, for example we use the expression of the example earlier was of commercial or investment real estate, where there’s a solid asset on hand. They know that there’s a value there but the borrowing could actually fall greater than the obligation or the value of that asset in a liquidation mode. Therefore, they buy somewhere between 30 and 50 percent.
David Nayor: And where does – where does a borrower – at what time in the cycle of either obtaining a loan or even after obtaining a loan can they or should they look at personal guarantee insurance?
James Coughlin: From an agent’s point of view in the insurance or risk management point of view, I think anytime you are seeking debt that might possibly have a personal obligation you should consider managing that risk. For the personal guarantee, anytime that is a risk for you as a business owner you should consider personal guarantee insurance. We can get involved as early as when they, business owner, is seeking credit. We can also get involved after the loan has been consummated and the risk exists they can also purchase coverage from us. We don’t want to look at the loans that are midterm, sort of 30-year mortgage, we’re in the 15th year and they’re looking at it going, “I’m about to crash. I’m looking for some help.” That’s not the spirit of the insurance coverage. But we can get involved all throughout the process of originating or right after the loan has been consummated to help them manage that risk.
David Nayor: Okay. And then on the flip-side, if a borrower has purchased the insurance are they in that insurance policy for the life of the loan or can they drop it at other times in between?
James Coughlin: That’s a great question. The product was designed by business owners for business owners. So we realize that it is not a life of loan insurance coverage that business owners want. You buy it for where you have the risk and you can drop it at any time. So from our perspective, we see most of our customers come to us with partnership issues, or they come to us when they have a comfort with risk that they’ve burned in the past. But they go from a million dollar loan to a two million dollar loan because of an expansion effort, they have added a new partner who’s not as strong as the existing partner group, and they now have a vulnerability. They buy it for a period of time. It’s typically – it’s an annual policy – but it’s typically held between three and four years or so that they hold it and realize, “I’ve gotten through the stress at hand and I don’t need it anymore.” And we’re – we’re very comfortable. We understand that. That’s what it’s designed to do.
David Nayor: Got it. And what is – what has been the bankers’ reaction when their borrower has purchased the PGI insurance? Has there been any type of reaction from bankers? Do they like seeing that? Do they – are they getting more familiar with the product?
James Coughlin: Well good news, no banker has objected to it. That’s the first thing, that’s been fantastic. On the spectrum of acceptance we’ve had lenders who are not aware that their customer, their borrower, and their guarantor has purchased it, because that’s a relationship between the carrier and the insured, doesn’t have to be shared with the lender. So it can exist on loans that are in place and the lenders never know about it.
When the lender is aware of it – we actually have it all the way to the other end of the spectrum where the lender is actually advising the customer when they object to, “We don’t like the guarantee, we don’t want to sign a guarantee, I’ve been a customer for ten years, why am I now asked for a guarantee?” The lender has actually extended our brochure or commented, “Hey, have you heard about it? We don’t sell it but it’s worth considering.” It’s a relationship management tool that some of our lenders have been using to overcome that objection of why they’re signing it. So again, no objections but various levels of acceptance to it.
David Nayor: Got it.
James Coughlin: Some lenders have pushed it to, “We want it as a credit enhancement, make it as a condition of the borrowing.” And we’re reluctant to go that far, but it is definitely a collateral enhancement to the program that if the lender’s willing to make a good solid loan now, this only makes it better. And I think – we talked earlier, how much is a guarantee worth when it comes time to call on it? This puts value back into that guarantee at that most critical moment.
David Nayor: Okay great. And just walk us through the pricing of the product so we can get our bearings on pricing.
James Coughlin: Okay. Risk-based pricing is what we have in place today. So the more risky the transaction, the higher the price would be. But our span runs approximately 60 basis points of the base value of the guarantee; not the loan amount, but how much you are guaranteeing, all the way up to – north of 2.5 percent. And that side will cover more risky, highly leveraged transactions, which we don’t have a substantial amount of appetite. The carrier is conservative about that. We’re not in the speculation business, we’re in the insurance business. So typically, on average, our portfolio today sees about a 1.2 percent of the face value of the guarantee is what our average portfolio is. And that – again, we have some that are materially lower and some that are higher.
David Nayor: Okay. And from a very, very high level, just so we can understand your risk-based underwriting, what are the categories that you’re – are you underwriting – underwriting the collateral of the loan, are you underwriting the cash flow, in-debt service coverage, are you looking for similar things that bankers and underwriters are looking at?
James Coughlin: Yeah, we actually look at exactly what the bank’s underwriting and the credit decision looks at. We look at the strength of the borrower and their ability to repay the loan. If that primary source of repayment through cash flow isn’t there, what is the collateral, that secondary source of repayment, look like, and especially in a liquidation scenario. The lender will seek a distressed sale and we know that the value of that will be materially impacted under distress. So when we look at that we then make a decision that says what is the risk to the insurance and the ability to repay? We factor it into our propagation table and just look up the price. So from a sophistication point of view it’s fairly easy for us to price because it is an insurance product. You sort of look up the table, but there’s a lot of analysis and knowledge – I guess experience that went into determining those propagation tables.
David Nayor: Okay great. Well thank you for that. That was a great overview on personal guarantee insurance. Before I move on to our last polling question, Jim, anything else that you wanted to mention on PGI?
James Coughlin: Well talk – what we do – it was brought up earlier, the recourse versus nonrecourse loan – our product doesn’t create nonrecourse loans. That’s why we only do up to 70 percent of that risk bearing. Because as the two prior speakers talked about, keeping the business owner with material skin in the game and focused on their solution-oriented performance is what we are here for. So we know that we are access to capital, a silent partner. I think someone talked about a guaranteed risk, you could take on additional guarantors and it’s very expensive. Well for the cost of a premium, you get that additional guarantor but now loss of the upside. So we become that silent partner with cash.
David Nayor: Got it. Excellent. Thanks again, Jim. And we’re going to launch our third polling question now and then we’ll get into Q & A. The third polling question is; in light of what you’ve heard today – and this is for borrowers and brokers on the phone – are you more likely to try to negotiate your next personal guarantee: more likely, less likely, no change. We’ll leave that up for a good 15, 20 seconds. And then we’ll get into some Q & A and bring all the panelists in to answer some of the questions. We’ve gotten a slew of questions online from attendees, so that’s great. So we’ll give another five seconds to the polling question and then we will release the results.
More likely, probably no surprise there. A couple of people, looks like, answered less likely, and then some no change. I guess it would come down to the deal and the borrower. But I think from this call there should be some good awareness on negotiating that PG and other products, like the personal guarantee insurance.
So let’s start in on some questions. First question that came in – and we’re just at 2:50, so we’ve got 10 minutes. The first question that came in; do you find that business owners understand the risk when it comes to PGs or do most see it as just the cost of doing business? Why don’t Jon Cosentino, why don’t you start off on that question?
Jon Cosentino: I guess my answer – it depends on what type of product that we’re working on. I think in a general sense for the small business owner that it’s pretty much accepted that it’s par for the course these days and the cost of doing business. I can say in my twenty years as a banker I can count on less than one hand cases where we’ve had to actually pursue it. So for the most part – knock on wood – we’ve been lucky with that.
David Nayor: Okay. Good. Next question that came in — and this is probably the most appropriate for Randy. The question – and I may try and summarize this – for legal and tax purposes for forming a corporation, is the separate entity – and I think what this attendee is asking is if there’s like a EPCOC structure when there’s real estate in an operating concern or company. It seems that banks in the government make it an issue — keeping the two separate – the question is how is it logical for the banks to make an owner sign something that says he will put up his personal assets to cover the business loan? It seems to work out for the advantage of the loan institution both ways? So I believe that this person is asking about an EPCOC structure. Randy, can you comment on that?
Randy Evans: Well, I’m not sure if I’m totally following the question. But yeah, I think, in my experience at least, the lender – the perspective of the lender is going to be to get sort of everything wrapped into the loan. So even in a structure where I have, let’s say, a separate real estate company and a separate operating company in – regardless of how the loan is structured – I guess what I have seen most often is that from a lender’s perspective, they still look at it as sort of all one entity. And so – or not one entity legally, I guess, but sort of as one business.
And generally, from a cross-collateral standpoint, and certainly from a cross-default standpoint, they generally will tie those two together. Now how the PG ties into that I guess depends on how the loan is structured. IF there are separate loans to the different entities and so forth. But I’m not sure if that’s answering the question or not, but that’s the way I’ve typically seen it structured.
David Nayor: Yeah and again, I’ll add to that. As Randy mentioned, if there’s a real estate company or eligible passive company in an operating concern, I think lender’s want to look at that as one entity. That’s either a co-guarantor on the loan and would require that personal guarantee. So wrapping everything together is common on the lending side. Randy, another question that came in, I think for you, is; does a letter of credit always require a like amount of cash pledged? So I think you had mentioned a letter of credit being a potential in lieu of some of part of the guarantee.
Randy Evans: Well I think the short answer is no. And the reason being that when you go to obtain the letter of credit it’s essentially obtaining another credit facility. And so it comes down to how the bank that’s going to issue the letter of credit underwrites the risk. It certainly will require collateral. But I don’t think that it necessarily requires that amount of cash. It can be based on the credit worthiness of the – whether it’s the company or the guarantor, I’ve seen it both ways where the company puts up a letter of credit, or where the guarantor actually obtains it personally and puts it up in lieu of all or a portion of the guarantee. It really comes down to how the issuing bank on that letter of credit is going to underwrite the risk.
But I think the short answer is no, it shouldn’t require basically a dollar for dollar – I mean if that were the case the other option would be to just pledge – have a segregated account and pledge a deposit account as collateral. But the idea behind the letter of credit is that while there is a cost to it, that generally it’s cheaper than putting up cash collateral or putting up a guarantee.
David Nayor: Got it. Thank you, Randy. So here’s a question. I think this would be suitable for Casper, if you’ve had this situation. How can a personal guarantee complicate or challenge relationships or partnerships that you have in your business? Have you run into that with any of your businesses that you’ve owned?
Casper Zublin: Yeah. I’ve just had the issue a few months ago. We bought a new manufacturing facility and the percentage of ownership between my partner and I is 75 -25. The bank refused to do a pro-rata guarantee and it’s a joint several. So the problem is the upside goes to one partner, three-quarters of the upside. And only one-quarter of the upside to another partner. However, 100 percent of the downside, should this venture not work out, can go to either partner. So if you run the numbers, one guy’s got three-quarter up and 100 percent down, and the other guy’s got one-quarter up and 100 percent down. So we have a risk issue. And so what we ended up doing is signing a side letter and since the loan just closed we’re actually talking about the insurance as well. It’s just whether or not we feel the risk – because my experience is most loans are the riskiest the first couple of years. And then you either know things are working out or things aren’t working out.
So yeah, I mean this idea of partners – and especially the joint and several, that things just – my attorneys have kind of educated me on it, it just kind of creates a real nasty thing when you’ve got guys that own different percentages. And then it also gets even worse, you know – having one partnership where one guy had a lot of money and one guy didn’t have any money. So here’s the other guy with the – you know, owned more didn’t have any money. The guy that had less had all the money in his personal bank account. He was really taking 100 percent of the risk, right?
That’s kind of the weird thing. If I have no personal assets and I sign a personal guarantee it’s worth exactly zero. If I’ve got a lot of personal assets I sign a personal guarantee it’s worth a lot of money. And I guess everyone’s experience is different and I want to comment on another question I heard earlier.
In the last three years I’ve had two guys who weren’t close personal friends, but they were acquaintances and they lost – one guy lost everything to a PG and the other guy lost a couple million dollars to a PG. I mean I know half a dozen people off the top of my head that – I don’t know – I think everyone’s experience is different, but I do see this as a – it’s been a significant issue and I’ve spent time with attorneys trying to draft side agreements and a lot of negotiating. Ten years ago I was able to negotiate a lot with PGs, get them released based on performance and a variety of other things. But in the last five years I’ve been completely unsuccessful. So if someone’s got a better idea have them call me.
David Nayor: Okay. All right, good. Here’s an interesting question. And the question is; doesn’t the SBA take the decision making out of pursuing a personal guarantee basically out of the bank’s hands? And maybe we’ll have Jim and Jon answer that question. SBA take the decision making out of PGs.
James Coughlin: Well — this is Jim. The SBA’s policy and procedures require that the lender take all available collateral and get guarantees with everyone with over a particular ownership interest. So if there is a 10 percent owner or better, they are required to get that guarantee. Also in the resolution of troubled debt, the bank is required to pursue the guarantee. So yes it does take the lender’s decision out of it. And several of my former colleagues — having been in commercial banking for 23 years – they approach it as small business administration lenders that it’s not an option. If you don’t want to sign the guarantee I can’t lend you the money.
Casper Zublin: Yeah, this is Casper. The loan I referred to is an SBA and that’s exactly what my attorney told me.
David Nayor: So there’s – if I’m hearing this right there’s absolutely no way out of the PG for SBA loans?
Casper Zublin: That’s what my attorney told me as well. And I said the same thing that Jim just said, that their required to pursue it, which I didn’t know that. That’s the part that I didn’t like.
David Nayor: Yeah I think from the lender’s perspective if that’s a requirement it could affect denial of their guarantee and obviously an SBA lender is looking to lend under the SBA programs to obtain the guarantee and essentially reduce their balance sheet risk. And that does make sense.
Here’s a question putting Jim in the hot seat. How does Asterisk assure the borrower that it will always have the cash that they will pay off their guarantee if needed?
James Coughlin: Well the great thing about that is that we actually have a carrier partner who is an A rated by A.M. Best entity. So they are publicly traded, they have a deep balance sheet. So it is not like you are worrying about whether I personally, James Coughlin, have the capital. It’s our carrier. And our carrier is very well rated and regarded. It had an upgrade in 2010 when most of the insurance industry was suffering downgrades, A.M. Best actually upgraded because of its credit standing and its ability to meet its obligations.
David Nayor: Okay. Great. And follow-up question; is the insurance sold throughout the United States?
James Coughlin: It is available throughout the United States, yes.
David Nayor: Okay. Anywhere else?
James Coughlin: Not yet. We actually have been asked to consider going into Europe and so that is on the table. There’s other products associated with guarantees that we’re looking at. But keep posted. Our website is available, I think you can see it, personalguarantee.com and find out all you need to know about it.
David Nayor: Great. So we do have more questions. It’s 3:02. If it’s okay with the panelists, we can stay on an answer a couple more questions. The attendees are still on the call so if everyone’s agreeable we’ll just keep on plugging at these questions and take another few minutes. So here’s a question, and a couple more for Jim. Are you aware if buyers have been able to obtain more favorable financing terms from lenders by offering to obtain PG insurance for the loan?
James Coughlin: I’d say yes, but cautiously. They’re not going to be able to borrow more money because of it, but sometimes they can get rate concessions. We actually have one lender who has gone so far as to give a full percentage rate off the borrowings to do it, which I thought was very fantastic and proactive on the lender’s part. But it will not replace the guarantee. That was one of the things we’ve seen most frequently, “Oh, if I buy personal guarantee insurance can I not guarantee the loan?” No. You need a guarantee to have the insurance to start with ‘cause that’s what it insures, that agreement. So yes, there are some aspects of it that will improve and some borrowers have been able to negotiate more favorable terms.
David Nayor: Okay. So that goes along with – I think someone mentioned that as a credit enhancement. Bankers may look at it as a credit enhancement as they’re underwriting the loan.
James Coughlin: Correct. We don’t encourage risk taking. So if they’re looking to go from an 80 percent loan to value to a 120 percent loan to value loan by buying the guarantee insurance, no. That’s encouraging risk taking. We would like to stay within the normal underwriting guidelines of a lender, and make prudent loans, and ensure that risk.
David Nayor: Okay. Good. Well here’s an interesting question. And it’s on signing a lease, which is also requiring a personal guarantee. And Randy, maybe you could answer this question. Can some of your negotiating tactics or suggestions be used in negotiating a personal guarantee on a lease?
Randy Evans: Absolutely. Yeah, I think the negotiating strategies and the options and the ideas that I was talking about are certainly not limited, in my mind, to bank guarantees. I think those are – can be certainly applicable to a landlord – a lease guarantee, or other types of personal guarantees as well. And I was going to ask just one clarification, maybe along those lines, from Jim. The PG insurance at this point, as I understand it, is limited to bank guarantees, is that correct? So I guess the question would be is that an available option on a lease guarantee, or a franchise guarantee, or some other type of guarantee?
James Coughlin: The answer is split. We can do other debt as long as it’s a secure transaction. We don’t look at unsecured transactions. So we have done seller take back notes that are secured by those assets of the business as a second position. We’ve taken a variety of other transactions. But as long as there’s a secured loan transaction, whether it’s a lender or a private lender, personal notes, we can do that.
Can it be applied to leasing? Not as of yet. Our coverage has been brought to our host – or home state for evaluation and they indicated that we needed to modify the language to meet the language in a lease obligation because our policies are written as a loan guarantee. So we are in the process of re-drafting that and we hope to bring that product to the market for leases and real estate occupancy shortly. I hesitate to promise when because I’ve been dealing with the departments of insurance for several years now and I can’t predict that approval.
Randy Evans: And Jim, just as a follow-up, what about guarantees on franchise agreements? Is that something that you’re considering as well or does that not really work?
James Coughlin: I guess the best way to put it is we follow the legal transaction of the guarantee. So I’d have to see what that language looks like. I know there are some in the market that are more franchisor friendly than franchisee friendly and therefore it wouldn’t be – it doesn’t apply. But I have not read every guarantee on the market, so I won’t even pretend to say that. The best way to put it is if someone has a guarantee within their franchise agreement we would love to read it and if we can put coverage to it we will.
Randy Evans: Great. Great.
David Nayor: Okay. So just a couple more questions and then we’re going to wrap it up. I appreciate everyone staying on the line. This is a good question, and Randy, I think you may be best to answer this. Does there need to be a substantial relationship between the provider of the PG and the business for which the collateral is extended? And I think what the attendee is asking is – and maybe this is one situation where there’s someone outside of the business, maybe not a manager or owner, who provides a guarantee, is that allowed?
Randy Evans: The short answer is yes. I mean it’s not – it certainly doesn’t have to be someone who is connected with the business. I think the reality is the less connected the person is to the business, either through and ownership interest or sort of day-to-day operation of the business, the more the risk they’re going to perceive in providing the guarantee and probably the more costly it’s going to be. But in terms of a requirement that that sort of rent a guarantor concept, I guess, there is certainly not requirement that that person be connected to the business.
David Nayor: Okay. Good.
Casper Zublin: Can I –?
David Nayor: Yeah, go ahead.
Casper Zublin: I was on a board of a company which I – and I had some equity and I signed a personal guarantee and then I left the board and sold my equity and they asked me to stay on and they didn’t want to pay me. And I refused. It was really simple. It was a very simple conversation because I no longer knew what was going on, I no longer had any impact, and they didn’t want to pay for it. And I’m going like this is ridiculous. So yeah, from personal experience I can say I had a situation like that.
James Coughlin: This is Jim. Casper, did your guarantee go away when you stepped down?
Casper Zublin: The loan was up for renewal. Had the loan not been in renewal my guarantee would have continued to be in effect, is what my attorneys told me.
David Nayor: Yeah, that’s generally the case.
Casper Zublin: So at the loan renewal I refused to sign and they – it caused an uproar, I will admit. But I was like, “Guys, this isn’t fair. If you want to pay me for it I’ll consider it. If you want to give me some information about the company and pay me for it, that’s about the only conditions, but if you don’t want to do either then it’s real simple, go get yourself another loan.” And so it wasn’t a happy situation, but I did not want what I think, Jim, you were suggesting to happen, which was – I don’t have any knowledge about the company but my guarantee is still on file with the bank. That would not have been good.
James Coughlin: And we see that with sellers of businesses where they’ve signed a note, they’re selling the business and the new lender is happy with the new borrower, but they’re not releasing the old business owner because they want to keep that in place. Especially when it goes intergenerational. In the franchise market we see that more frequently, where parents are turning it over to the children, siblings are sharing wealth over time and managing that experience. Lenders are reluctant to release guarantees, especially if there’s still any tie to that entity.
David Nayor: That’s interesting. Jim, so that could be relevant for the seller or someone who’s stuck as being guarantor of a loan but really is arms-length distance from the operation of the company. PGI or the insurance company could be a solution for that.
James Coughlin: Yeah. I think the best example was husband and wife. Husband signs a guarantee and now is divorced from the wife. The bank wouldn’t release him but the courts released him from the marriage agreement. He said, “I don’t want the loan anymore.” Sorry, the lender would not release him. So our coverage helped him get comfortable with the fact that he still runs the risk for his x-wife’s practice.
David Nayor: That’s interesting. There was a question that came in on spousal interest. And the question was; is there a way to title assets to protect a spouse before starting a new business or borrowing? Randy, maybe you could comment on that. And before you start, Randy, I will say that as a former lender spousal interest was something that – loan after loan we had to look at. It was a real issue in underwriting the loan and with the borrowers. So it’s an important issue that we know of for the borrowers.
Randy Evans: Yeah, I think the answer to the specific question is it depends on where you’re at. It depends on if you’re in a community property state or not because if not, then yes, you can certainly title assets in the name of either the husband or the wife. And to the extent that, let’s say the husband signs a PG and the wife does not. Her assets, to the extent that she has assets in her name solely and it’s not a community property state, then those assets should not be subject to attachment by the lender pursuant to their guarantee from the husband.
What I see a lot of time is in states – I don’t see a lot of spouses sign actual personal guarantees, but what I do see is in those community property states a lot of lenders will use a spousal consent where even though the spouse is not signing onto the obligation of the guarantee, they are acknowledging and consenting to the fact that their property, to the extent that they have an interest in community property with their spouse, that that property is subject to attachment to satisfy the other spouse’s guarantee. So there’s a couple different issues there and it really depends on what state you live in.
David Nayor: Got it. Got it. Well great. Well we are now at just about 3:15 and we’ll – we’ll take this time to wrap everything up. And I want to first thank our panelist, Jon Cosentino, Casper Zublin, Randy Evans, and James Coughlin. Great job on this panel. I think our attendees have pulled some really great information from the panel. And just a reminder we have recorded the session. So for those of you who have asked for kind of repeating the questions, you can just go to the recording. Our panelists’ bios are at the URL that’s on the bottom of your screen right now so you can always contact our panelists and we encourage that you do so for additional questions about their products and services.
Just a quick note on some upcoming events. Franchise Leadership and Developing conference is October 3 – 5, in Atlanta. Boefly will be there. We do have in our webinar series, Boefly webinar September 18th, Best Practices in Buying and Selling a Business. Conference, National Association of Government Guaranteed Lenders, or NAGGL, October 25 – 28, in Las Vegas. We will be there. And the Restaurant Finance and Development conference in Las Vegas in November 3 – 5.
Also want to thank Beth Soloman or the IFA for her participation in today’s conference. And thank you to all the attendees. You can find more on Boefly.com/blog/events for upcoming events. And lastly, we just have an exit survey. I’d really appreciate if you guys will – will just take the time to click on a few more buttons as you exit the panel. And we will be publishing the result of all of the surveys to all attendees. Thanks again to the panelists, thanks to the attendees, and enjoy the rest of the day.