Street Smarts: Free At Last

There's nothing like getting rid of those personal guarantees.

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There's a quandary many of us face once our companies move beyond the start-up phase and begin to grow rapidly. To finance the growth, we get a loan from a bank, which will lend us the money only if we agree to put up our personal assets as collateral. The more capital we need, the bigger the loan we get, and the larger the personal guarantee becomes. It's our debt to the bank, and it hangs over us like the sword of Damocles. No matter how much money we make, no matter how high our net worth is outside the business, we remain at risk of losing everything, even our homes, should the company fail.

To be sure, the banks don't really want our homes and probably won't take them away from us in the event of bankruptcy. Lenders insist on guarantees mainly to make sure people stick around if companies tank before paying off their loans. Even in bankruptcy, after all, your business may still have valuable assets--uncollected receivables, for example--and you know better than anyone what they are. Without the guarantee, however, you have no incentive to stay and help, since you won't be getting any of the money. It will all go to your creditors. The personal guarantee gives you a powerful reason to remain on the job. As long as you do your part, the bank will usually be willing to work out a reasonable settlement with you.

But that doesn't make the guarantee weigh any less heavily on you. Every entrepreneur I know who has a bank loan yearns to get out from under his or her personal guarantee. Most people believe there are only two ways to do it: sell the business or pay off the debt. I used to dream about paying mine off as well. Like other members of my generation, I had been raised to believe that debt was bad: If you had any, you should get rid of it as soon as possible. I thought, "Once I pay off these loans, no one will have a claim on my business; I'll be able to keep all the money I'm now spending on interest, and I'll be free of my guarantees." Fortunately, I didn't follow through on that. If I had, I would have hurt the business. In a growing company, debt is your friend. You need it to capitalize on the opportunities available to you. If I had focused on paying off my loans, rather than building the business, I might have escaped my guarantees, but my company would be much smaller and less profitable than it is today, and it would be worth a fraction of its current value.

It turns out, however, that there is a third way to get rid of your personal guarantees, and I took advantage of it last year when we replaced our bank loans with a loan from a nonbanking financial company. In our case, the nonbank was an investment firm we'd been doing business with for more than 20 years. We'd partnered with it on several fairly large deals, including the acquisition of a huge chunk of land adjacent to mine (see "The Art of the Deal"). In the process, we'd built great relationships with the firm's leaders and staff. They understood our business, and they knew who we were, how we operated, and what values we lived by. They also knew we'd always delivered on our commitments, even when doing so created hardship for us, and they respected us for it. There was trust all around. So when we decided it was time to refinance our debt, they were the people we turned to.

Now, I should note that we had great relationships and an impeccable track record with our banks as well, but I've never known one that would let business borrowers out of their personal guarantees. If you ask why not, the banker says, "It's just not our policy. We can't do it." While I could understand why banks have such policies, I really didn't want to go on living with the discomfort you feel when most of your wealth is tied up in one business and someone else has a claim on any assets you own outside the business. I knew that I'd feel better without the personal guarantees, and better still if I could diversify my portfolio by taking some of my equity out of the company and investing it elsewhere.

My partner Sam and I came up with a plan to do both. We approached our friends at the investment firm and told them that we had relatively little debt for a company our size and were thinking about borrowing some more money. They said they could lend us up to five and a half times EBITDA (earnings before interest, taxes, depreciation, and amortization). We didn't want anywhere near that amount. Instead, we suggested another approach. We pointed out that we were spending $3 million a year in interest and principal on our bank loans, which were structured more or less like a home mortgage. That is, we had level payments over the terms of the loans, but in the beginning most of the money went to pay interest, whereas in the end most of it would go to pay down principal. Because we'd taken out some of our loans many years earlier, our interest payments were less than half the total annual bill. That was important because you pay interest with pretax dollars and principal with after-tax dollars. "How much could you lend us," we asked, "if we continued to pay $3 million a year but with all of it going for interest rather than principal?"

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