Many British Columbia small business owners are also home owners. In recent years, BC’s rapidly increasing real estate values have enabled many small business owners to look to their homes as a ready source of cash or security to finance their business ventures. This may be a risky strategy, but for many brave small business owners, it is the only real option available to get their business started.
Understanding the Risks
Practically speaking however, whether you are drawing from an established homeowner’s equity line of credit (“HELOC”) to personally fund your business venture or seeking direct financing for your business entity from a bank or other third-party lender, there is a similar amount of risk involved. In the former scenario the money has been borrowed in your personal capacity, while in the latter scenario the lenders will usually require that the borrower provide a personal guarantee in support of the loan to their small business entity. In either case, if your only significant asset is your home, then you’re putting it at risk.
Personal Guarantees for Your Business Entity
Many small business owners do not appreciate that their business, if it is incorporated, is a separate legal entity – essentially like another person. One of the primary reasons small business owners incorporate is to limit their personal liability should the business falter for some reason. However, in providing a personal guarantee to a creditor, the business owner effectively removes much of that protection. Providing a personal guarantee ought not to be done lightly.
Unfortunately, it is not uncommon for us to meet small business owners, often in times of financial difficulty, who simply don’t know if they have provided personal guarantees to creditors – be they lenders, equipment lessors or landlords (if not all the above) – in support of credit granted or services provided to their small business corporations. It is important to understand if you have provided a personal guarantee on behalf of your business entity…and if possible, try to limit it.
You’re Entitled to Security for Your Loan Too
Further, should you choose to personally lend money to your business entity (as in the HELOC example above) then the prudent course of action is to take security for your advance – just as a third-party lender would. This will require the assistance of a lawyer and is best done concurrently with the advance of funds. If your business entity later seeks a loan or lease from another third party creditor who requires first position security, you can always agree to subordinate your security position to theirs. Importantly though, you remain a secured creditor for your advances to your business entity. This allows you to avoid being an ordinary unsecured creditor in the event that the whole business venture goes pear shaped, at which point your security could become a valuable bargaining chip in a restructuring.