When establishing any new business or restructuring, steps should be taken to mitigate exposure to any loss to the individuals in the event the business should fail. Business owners should hope for the best but plan for the worst.
Financial institutions when deciding to approve a loan will be primarily concerned with repayment. Often lenders will require a personal guarantee from the individual business owners.
Individuals, when realising their investment through the sale of their equity in the enterprise conducting the business, often fail to take the necessary steps to release themselves individually from any personal guarantees offered to finical institutions and other third parties, at the time of sale of their equity.
This means the new proprietors continue to benefit from existing finical facilities as guaranteed by individuals no longer associated with the business.
The obvious risks are that should those new proprietors fail, then in the event of insolvency the individual previous owners become primarily liable pursuant to the terms of the guarantee and indemnities.
When the individual or entity sells or transfers its equity in an enterprise, any previous guarantees or indemnities should be revoked and replaced by new guarantees and indemnities as offered by the new business proprietors.
It is also possible when providing a guarantee and indemnity to negotiate both the sum that shall be guaranteed and the time period in which the guarantee and indemnity shall remain in place. This will reduce or eliminate liability for loan extensions and renewals.
The best time for individuals to protect their rights and assets is before loan documents are executed. Advice should be sought before entering into any new business venture, executing loan documents or selling out any equity in an enterprise.
Disclaimer: Readers should seek independent legal advice as this article is for information purposes only. Daniel Cole is a director at Beck Legal, Bendigo.