Startups and struggling small businesses in need of a cash infusion might look to small business loans or other forms of financing. And when they do, they often need to bring guarantors to the table. If I were ever asked to be a guarantor, I would graciously turn down the opportunity. I can explain why in two words: money judgments.
Recent research into how judgment collection agencies go about collecting from businesses led me to this idea of guarantors. According to Salt Lake City-based Judgment Collectors, businesses that go under are very difficult to collect money judgments from. But if such a business has guarantors attached to it, a collection agency can go after those entities.
More About the Guarantor
Guarantors can be business entities themselves. But more often than not, they are individuals. Imagine the owner of a startup looking to secure second or third round financing. He turns to a wealthy relative as a potential guarantor.
By signing on as a guarantor, this relative is guaranteeing payment of the business owner’s debts. Should the business owner default, the relative is legally responsible for paying.
If you are familiar with cosigning for a car loan or mortgage, it is the same principle. A person who cosigns for your car loan is legally obligated to pay the loan should you default. Business guarantors take on the same legal obligation on behalf of startups and small businesses.
Going After Guarantor Assets
A judgment collection agency might be wary of taking on a case involving an individual judgment debtor with little income and few assets. Such a debtor is like a stone from which you cannot draw blood. But a failing business with guarantors is another matter.
Guarantors make all the difference in the world. For starters, it is expected that a guarantor has some amount of wealth or business assets that would qualify him to guarantee someone else’s business debts. You are talking about either significant income streams or real estate. In some cases, you are talking about both.
It’s also assumed that most guarantors don’t want to deal with the consequences of judgment liens and writs of execution. So going after guarantor assets is a winning strategy more often than not. And that’s exactly why I would never agree to be a guarantor for a startup or small business.
Personal and Business Assets
When a guarantor is an individual, their business and personal assets are both up for grabs. A judgment creditor could go after nonexempt real estate, vehicles, collectibles, jewelry, and even cash. Imagine being a guarantor at risk of losing a vacation property because a friend of yours defaulted on his financial obligations.
Any business assets the guarantor owns could also be targeted. Again, that could mean real estate. But it could also mean equipment, machinery, company trademarks and patents, accounts receivables, etc.
Collecting Without a Guarantor
Knowing what I now know about guarantors, the possibility of having to face a money judgment is enough to dissuade me from taking on that responsibility. But what about the judgment creditor’s perspective? What does he do when a business debtor doesn’t pay and has no guarantors?
Judgment Collectors says this is fairly common when startups or struggling small businesses close. Without ongoing business activities and any guarantors, a judgment creditor is basically out of luck. There is no one to collect from.
I have not thought much about being a guarantor for someone else’s debt. But now that I know the potential consequences, it’s not something I would ever consider. My take is simple enough: just say no.