It is not unusual for businesses to borrow money from banks and other
financial institutions. Loans and lines of credit can help even out the ups and
downs of cash flow so a business can smoothly meet its payroll and other
financial obligations. Borrowing can also help a company capitalize on unique
growth and profit-making opportunities. While borrowing money to run your business can be beneficial, without a plan, it can also create difficult problems.
Your Personal Guarantee
When a bank lends money to a business, it normally requires the owners to
sign personal guarantees. When you give a bank your personal guarantee,
you have signed the loan documents twice: once as an officer of the business
and a second time as a guarantor. Personal guarantees often permit the bank
to demand repayment from either your personal assets or your business assets
if there is a default. The bank gets to choose.
This potentially presents two problems:
Your personal guarantee may create a serious financial problem for you and your family. That’s because in the event of a default, the guarantee permits the bank to come to you personally for repayment. It doesn’t have to go to the business to be repaid; it can come straight to you. If you were to die unexpectedly, your personal guarantee potentially puts the bank ahead of your spouse and children in the distribution of your assets. After the bank is paid, your family could then seek reimbursement from the business. Unfortunately, this could take months – if the business is able to repay them at all. Until then, your family will have to bear the loss.
There is a different problem if your business has multiple owners. Suppose your bank lends your business
money for capital and expansion and all the owners sign personal guarantees. If one of the other owners dies unexpectedly, the bank may have the right to call the loan and demand the entire repayment from you. The bank may not have to look to the business or to the other owners to get repaid. It may be able to recover the entire debt just from you. Then it will be up to you to get the business or other owners to reimburse you.
The Solution: Key Person Life Insurance
When you personally guarantee the loans of your business, you are personally taking on a new financial risk, a risk you probably don’t want. To transfer some of this risk back to the company, your business can purchase and own a life insurance policy on each owner and key employee. The policy death benefits are payable to the business as the beneficiary and can be used to repay the outstanding loans when the insured dies. These policies protect you if a co-owner dies. They also should protect your family in the event of your death. If the policy is properly managed, the death benefits may be income tax free under IRC Section 101.