When my friend and I bought a building, we set up a corporation to purchase it. Our thinking was to have the limited liability that the corporation would provide, as well as get the preferred corporate taxation.
We’ve recently run into some cash flow issues (perhaps that’ll be a future post) and my partner set up a loan with one of the major banks. The bank wants us to fill out a form with our personal financial data.
My response, when I saw this, was that since the CORPORATION is borrowing the money, the lending decision should be made based on the CORPORATION as an individual, not us. To my mind, if we provide our personal details, we’re clearly going to be guaranteeing the debt (which seems to undermine a lot of the value a corporation is supposed to provide).
My partner insists that this is how things work for small corporations and that no lender will loan us any amount based on the corporate assets (which I believe comfortable exceed our current debt level). I think that the corporation should be able to borrow money itself (although obviously a smaller amount then it could borrow if we were acting as guarantors).
Do any of our hyper-intelligent readers know which of us is right (ideally with a link to “official information” so the victor can rub the loser’s nose in it)?
Secondly, if banks are perhaps more conservative lenders, who should we be talking to in order to arrange corporate financing without the personal guarantee? All the corporate lending websites that turn up on Google look pretty dodgy. I don’t think a mortgage broker would be the person to talk to, but I can’t really think of who else to contact…
12 replies on “Corporate Borrowing”
Mr. Cheap,
the problem is that your corporation is very small and has only one building. Therefore, as an individual, your corporation is not really interesting to lend to. You may find private lender or specialized lender but they will surely charge extra interest on the loan “due to the potential risk of borrowing to such a small corporation” ;-).
The borrower has to demonstrate repayment capability clearly. (especially now after all the financial mess all over the place).
If your corporation cannot demonstrate this, then the bank may look at the people behind the company. i.e. you and your friend.
This is especially so if the corporation is new, has only one source of income, blah, blah, blah.
I think the bank is not unreasonable.
It is customary for a bank to request personal guarantees on loans–I went through this at start up for a company. Going back for a line of credit 6 years later I refused to personally guarantee the LOC because the corp had a proven track record (it’s own good credit rating) of repayment. You don’t have a lot of leverage with the bank at this point. Note if you go with a private lender, banks will not recognize the credibility you build up there. A spouse would likely have to get ‘independent legal advice’ to fully understand his/her share in your matrimonial property is fair game if your corp chokes and you’re on the hook.
Shop around banks–some are more open to small corp business. The bank that I went with eventually received all my personal business as well.
FB: Yeah, I understand that, sadly I would have hoped they would have taken the attitude that its worth lending to a small corporation to build a relationship for when it becomes a larger corporation. I guess “relationship banking” only goes one way 🙂
FS: We certainly can demonstrate repayment capacity (both through income and, in the worst case scenario, equity and the value of the building).
Leslie: That was my one feeling, is that since the corporate was so young that they would be reluctant to lend to us without a longer operational history. Good advice to try other banks (and give our current & future business to the one that’s most reasonable).
Banks have no obligation to loan money to anyone. Sadly, they chose the criterias. So, both of you are right I’d say.
CtR.
Hi, I have 3 coprporations setup in past and when applying loans to bank, they always wanted information of me nad personal finances. I guess for small businesses it is how it works.
Slightly off topic but having to do with investing in rental properties, several years ago I read an excellent book by Lionel Needleman called Buy Rent Sell–it’s out of print but try the library (Canadian publication). While it was published more than fifteen years ago, the principles are still relevant. A review of it is here: http://rireb.blogspot.com/2005/12/buy-rentsell.html
If you are a real estate investor and do not have other assets to attach to in case of non-payment, a personal guarantee is conventional. If you use the same bank often and you have a lot of equity in one of your properties, you can negotiate for a 2nd mortgage to be registered rather than a personal guarantee.
Negotiate a limited recourse guarantee which caps your personal exposure to some dollar amount.
Not to be a house-breaker but the bank will ask for the personal guarantees to be on a joint and several basis which means if one of you cannot pay, the other is obligated for the entire obligation (if one of you declares personal bankruptcy, the bank gets nervous and calls in the entire loan). Better make sure both of you have sufficient assets so you don’t leave the other one hanging.
I have friends/colleagues with businesses in the $9-10mil. annual revenues. They are still considered small by lenders and a personal guaranty are still generally required for all loans. Even in cases where the loan is partially government guaranteed, such as SBA loans, the banks still require personal guaranty.
Really, for smaller companies the liability shield that a limited liability entity provides is for tort liability and perhaps trade creditors. The borrowed $ are still carried by the individual owners every time.
abc: Thanks for sharing your experience. Glad to hear I’m not the only one :-).
Leslie: That does sound like an interesting book, thanks for the recommendation.
TMW: I think you’re right. Good advice for us to cover our asses.
Mike: I thought you Americans handed out credit like candy? 😉
Thanks for all the thoughts guys, I guess my partner was right…
Nah, we just use candy to secure the loans. 🙂
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