Thanks to guest blogger Andrew Bermudez (@finditfillit), of Lee & Associates in Irvine, CA, for submitting this great post describing ways for young companies deal with a personal guaranty.

Companies that have been in business many years have a much easier time getting approved by a landlord for a lease. However, companies that are just starting out with very limited or non-existent business history have a many hurdles to overcome. One major hurdle for business owners is when a landlord asks for a personal guaranty. A personal guaranty is essentially what it sounds like, a guaranty from the person soliciting the loan/credit/contract to fulfill a contract should the entity fail to meet its obligation. However, a business owner doesn’t always have to resort to a personal guaranty when they don’t have business history.

There are actually a few options. One is providing a Letter of Credit to the landlord and the other is providing increased security deposit to secure the office lease. The main concern of the landlord is that he or she wants to feel assured that a tenant with very little rental or business history will pay the rent. That’s why they ask for personal guarantees, so if the company defaults on the rental payment, the person guarantying the lease immediately takes over the payments

Let’s look at our alternatives closer:

Letters of Credit: Plain and simple, a letter of credit is a bank’s promise to pay a certain amount that’s owed by a tenant or a borrower. Banks issue letters of credit as a way to ensure sellers that they will get paid, as long as they do what they’ve agreed to do. This is usually a more common route for small business owners or startups with not a lot of business history or revenue. This also appeases a landlord who is considering a startup business with limited revenues or credit for an office lease.

When a tenant gets a letter of credit from the bank, it basically performs the same thing a personal guarantee. If the tenant defaults on its rental payment, the bank takes over and begins to paying rent to the landlord. It is basically the same thing a personal guarantor would do, with the exception that it is a bank.

Increased Security Deposits: Landlords will forego the personal guaranty if they feel comfortable with the tenant’s business plan, plus an increased security deposit usually makes them feel comfortable that if the tenant goes out of business, they have this additional money to count on while they get the space vacated and re-leased to someone else. Another good thing about increased security deposits is that you can negotiate with the landlord certain things like having a portion of the deposit burn-off as prepaid future rent, provided you don’t miss a payment the first or second year, etc.

Things to keep in mind: Letters of credit diminish an existing line of credit, and are reflected on the contractor’s financial statement as a contingent liability. Having assets tied up are counter-productive to both the owner and contractor. The business owner’s cash flow in funding initial stages of construction and retention amounts throughout a contract term can be adversely affected when liquid assets are pledged to a bank or the bank reduces its borrowing capacity as a result of the issuance of a letter of credit. Also, increased security deposits may tie-up your starting capital and put strain on your cash-flow.

Conclusion: Always keep in mind that everything in life is negotiable, you just have to understand where both parties are coming from, and address their concerns in a way that you are able to come to a mutually beneficial agreement. Increased security deposits and letters of credit are a great thing if you are very concerned with personally guaranteeing an office lease. We hope this helps all of you getting your business off the ground, or those of you with limited credit.