When entering into a commercial real estate lease most landlords are going to require a personal guarantee, because if they don't and the tenant defaults on the lease the landlord is out of luck. These days it's normal practice for a landlord to do a thorough credit/financial check to ensure the owner or the business has the financial capability to back up the guarantee.
What is a Personal Guarantee?
A personal guarantee is a commitment by the individual/guarantor to personally pay back the commercial lease obligation in the event the business fails and/or files for bankruptcy.
The requirement of a personal guarantee with office, warehouse & retail space leases is pretty common these days especially after the the 2008 recession. Most startups and newly formed businesses without a track record will be required to sign one. If you refuse to sign one they won't lease you commercial space.
Why do Landlords Want a Personal Guarantee?
- For one if the space needs a lot of improvements the landlord may put a lot of money into the construction. If you default on the lease they get stuck with the bill.
- Additionally the landlord could have leased the space to someone else so there is lost opportunity costs there.
Should You Sign a Lease that Requires a Personal Guarantee?
If you are a startup that is planning on future growth or just not sure about the future then you want to limit your personal exposure. Statistics show that around 50% of new small businesses and startups will be out of business within 5 years. If the landlord is requiring one then do what you can to limit the guarantee to only the out of pocket costs the landlord incurs or find a landlord that does not require one.
If you are an existing company with great credit & and stability you shouldn't need to sign a personal guarantee, however if you do you more than likely have the ability to back it up.
Negotiating a Personal Guarantee on a Commercial Real Estate Lease
- Make sure to read the lease carefully, especially the section on personal guarantees. You want to know how much you would be obligated to pay and for how long.
- Do what you can to limit the guarantee to only the landlord out of pocket costs.
- Ask for a time limit – Sometimes landlords want you to prove yourself. If your lease is 5 years ask that the personal guarantee expire on the 36 month.
- If you have the the financial means offer to provide a letter of credit for a set dollar in lieu of a personal guarantee. This can be tapped in the event you default.
- You could offer to guarantee the commercial rent for a set period of time after an early termination. For example if their is 3 years left the landlord has to try and release the space. In reality the court won't let a landlord charge you for all 3 years. They will typically look at the existing leasing market to determine about how long it would take the landlord to release the space. That is typically all that they will require that you pay.
- You could also just propose that you pay 6-12 months of rent in advance or guarantee the same amount only if you default.
If you have any questions about this feel free to give us a call or contact us via our website.