CAN Borrow Does Not Imply SHOULD Borrow

When should you give a personal guarantee? When you are able to and intend to deliver on it and when doing so is aligned with your values, as they relate to yourself and the others involved in the relationship.

In the movie, “The International,” a wealthy business tycoon explains the essence of the banking industry: “The International Bank of Business and Commerce is a bank. Their objective isn’t to control the conflict, it’s to control the debt that the conflict produces. You see, the real value of a conflict, the true value, is in the debt that it creates. You control the debt, you control everything. You find this upsetting, yes? But this is the very essence of the banking industry, to make us all, whether we be nations or individuals, slaves to debt.”

This sounds cynical, and is somewhat so. But the above description should ring true for everyone who has ever taken out a credit card or a mortgage or car or business loan (or has even been offered one, for that matter). The sad part is that except in cases where the customer didn’t understand the terms, the resulting enslavement is of our own choosing.

Credit is becoming more and more available in the developing world and unfortunately we see in our clients where they are becoming more and more willing to take the “risk” and accept credit from financial institutions in return for personal guarantees. Below are some principles by which to determine when or if it is wise to take such a risk.

  • My father used to say, “don’t gamble what you can’t afford to lose.” You may very well have to deliver on your personal guarantee. It’s not just a piece of paper. The bank will legally have the right to take everything you own and to even burden your future earnings. And they will absolutely exercise this right. You have to determine if you can afford to lose the amount that is being guaranteed.
  • A guarantee has legal and moral meaning. It is called a guarantee for a reason. It’s a promise. It’s a commitment. You have to determine if you are willing and able to put your integrity on the line and actually perform on that commitment.
  • Can you guarantee that the assets serving as collateral for the underlying loan are sufficient to fully pay off that loan in the case of default? When cash flow is insufficient to service the debt and it goes into default, the bank will foreclose on the assets and then liquidate them. Will the funds from the sale of those now distressed and discounted assets be sufficient to pay off the loan? If you are confident enough of this, then there is no risk in a personal guarantee because it won’t need to be exercised.
  • This following is a technical point, but relevant. A personal guarantee is just another form of collateral for the bank. Banks will strive to acquire as much collateral as they possibly can in order to minimize their risk. The borrower should push as hard as possible to provide as little collateral as possible in order to minimize his risk. This is just another negotiating point. And there should be no “give” without “take” in the negotiation. In other words, save the incredibly valuable and risky personal guarantee for when it really matters or make sure you receive significant concessions from the bank in return for a personal guarantee.
  • What is the alternative to not providing a personal guarantee? A business loan is a loan for a business. The bank makes the loan because it believes there is a good risk-return tradeoff. If the bank isn’t willing to loan the money based on the business, then there are more important issues to consider regarding the business. This is an appropriate place to reference another valuable principle: “don’t borrow money if you wouldn’t loan it to yourself,” or “just because a bank is willing to loan you money doesn’t make it a good idea to borrow it.”

Unfortunately bad things do happen and businesses are not always able to pay back loans. Consider whether you are willing to sell your own personal assets or leverage your future earnings and risk your personal integrity before you decide to provide a personal guarantee. Sound principles for dealing with banks are as true where you live as they are in Rwanda.

-Dano