RevenueLoan Blog

July 20, 2011

On Personal Guarantees

Filed under: educational,investment philosophy — rlucas @ 4:46 pm

I. No Free Lunch.

“Unsecured Business Loans!”  “No Personal Guarantees!”  “Free Beer and Hot Girls!!”

Yeah, right.

Lots of folks are clearly interested in the question, “how can I get financing for my business without taking on a huge personal risk of ruin?”  And, just like any time there’s a lot of folks interested and highly motivated, in a complicated problem involving money, there’s a huge shitstorm of shady mofos ready to please — or so they claim.

The fact is: small businesses are hugely risky, and nobody is going to take that risk fully (or even mostly) away from the vast majority of entrepreneurs.  Up until a business has $20 M (or more) in revenue, it might as well be viewed as just an extension of the entrepreneur’s personal credit.

So, you can pretty much count out anyone who promises to give you an unsecured, unguaranteed business loan (unless your company happens to be rated by Moody’s and can issue your own bonds).

(Yeah, VC backed companies are different — but there have also been fewer than 30,000 VC backed companies ever in the history of the universe — vs. the 30,000,000 businesses currently in the US.)

II. No Free Lunch … Except for the banksters.

This is true for banks, credit card issuers, and specialty financiers all the same.  Seriously: go ask for an SBA loan … personal guarantee.  Try to get a credit card in the name of your business … no problem, with your own FICO score and personal guarantee.  Asset backed loan or merchant advance?  Betcha dollars to donuts, personal guarantee.

(In fact, it’s kind of a farce that these products hold themselves out as “business finance,” so as to avoid the laws and rules of usury and consumer protection.  After all — a business loan with a personal guarantee is kind of a mirror reflection of a consumer loan with a business as co-signer.)

So, here we are at Lighter Capital (nee RevenueLoan) with a quandary.  We kind of hate the idea of a personal guarantee on our RevenueLoans.  We find it farcical and repugnant that others advertise themselves as business financiers but fully expect that many of their businesses will default, and they’ll wind up going after ex-entrepreneurs who’ve schlepped back into day jobs to scrape back pennies from their paychecks.  We don’t want to do that.

III. Never say never?

But we’ve run into a few situations, especially in the last several weeks, where the word “… guarantee …” has cautiously, and none too enthusiastically, crossed our lips in conversations with entrepreneurs.  This has caused a few awkward moments, where a concerned and ticked-off entrepreneur wonders if we are trying to bait-and-switch him, and we wonder what we did to be so offensive.

So let me get this off my chest right here: We at RevenueLoan don’t /always/ ask for personal guarantees.  But we don’t /never/ ask for any form of guarantee.  Sometimes, we think a certain form of “Working Guarantee,” perhaps tweaked or limited, is the right thing to do for all concerned.  Here’s why.

Oftentimes, we want to find a way to fund a company, but we feel stuck around the “intellectual property [IP] collateral question.”  You see, the main reason we ask for a security interest in the IP of our customers’ companies is NOT because we figure we can sell the IP in a pinch and get our money back.  Instead, the IP is our guarantee of “stickwithitness.”

IV. Sticking with the business, NOT sticking it to the entrepreneur.

If you’ve got the recipe for the world’s best chocolate chip cookie (hi Michael!) or the world’s smoothest — and only — goat milk frozen yogurt (hi Laura!), then we trust you are motivated to USE that recipe.  And so we take a security interest in the recipe — not because we want to “repossess” the recipe, but because it’s what binds us together.  Keep using the recipe, please, and keep paying us our agreed % of revenue.  As long as we’ve both done the right math at the beginning, this should be totally doable and win-win.

However, if the secret to your business success is not in a recipe or a formula, nor in a patent or trademark or other form of “IP” that we can use as security — if it’s your personal Rolodex and know-how — then we’re in a bit of a bind.  Let’s say we’re promised 5% of Famous Joe’s fortune-telling practice revenue as repayment, with no security whatsoever (no IP).  Famous Joe uses our funds to market his services, etc., and he keeps 95% of the revenue he generates.  But if Famous Joe decides to quit his business, move across the street, and reopen his practice under a new company name, he’ll still be Famous Joe and keep his customers — but he’ll now keep 100% of the revenue he generates.

Needless to say, this is a troubling scenario for those of us who make the investments.  Not because we don’t trust Famous Joe to do the right thing — but hey, this is business, and we never like to set up scenarios that give incentive to do the wrong thing.

V. Names have been changed to protect the awesome.

So, if you’re still sticking with me, you can understand the role that an IP security interest plays, even if it doesn’t act like traditional collateral (repo and sell it).  But what about those cases where a company doesn’t have any IP to speak of?

(Note: this doesn’t mean the company isn’t “intellectual” or that it doesn’t have any value.  It just means that the IP isn’t in an external, recognizable, legally demarcated form like patents, trademarks, copyrights on software, etc.)

This could be know-how, relationships, golden Rolodex — let’s take for example a very savvy event promoter … let’s call him Fabio.  He may know the marketing techniques to get thousands of people to show up, the right people to get venues and attractions set up at cities around the country, and the skills to run the event smoothly, safely, and profitably.  Maybe he’s got a revenue track record in a few cities and wants to go nationally, good gross margins, and a good growth rate — but no hope of getting banks or VCs interested — in other words, Fabio’s a great RevenueLoan candidate.  But: without any IP, how are we to solve our “stickwithitness” structure problem?

Right now, we think the answer is this: we ask for a guarantee from the entrepreneur that he will stay working on the business; that he won’t throw in the towel early; and that he won’t go work for (or start) a competitor for a while if, for whatever reason, things go pear-shaped.  And since this is a money-based game we’re playing, we ask for the entrepreneur to stand behind that with, yes, money he personally guarantees.

VI. More than (just) words.

We call this a “Working Guarantee,” to differentiate it from a straight up, unconditional, “personal guarantee.”  But it’s not just “spin” B.S. on our part.

We typically will put some kind of limitation on the guarantee, that basically suggests that so long as the entrepreneur is in good faith putting in full time on the business, and the business is paying its RevenueLoan percentage (even if it’s only 5% of $1.00 a month), we will not come after him for any money personally.

Also, we are open to tweaking the amount that is covered by the working guarantee — or agreeing to milestones where that amount is reduced or eliminated.

VII. Complicated?

So now that we’ve just shown you all our negotiating cards … are we just plain nuts?  Is this too complicated and weird?

Hardly.  We think this is part of a natural evolution of business finance.  Keep in mind that our entire business financing infrastructure was build to help joint-stock corporations purchase looms and waterwheels and drill presses and big brick factories.  (OK, in fairness, the VC part of that infrastructure was basically created in the ’80s to fund Genentech, Max Headroom, and Starbucks.  It just happened to work for fiber-optic switches and enterprise software, too.)

So, when you see a bank using the same old forms from 1899, and just filling in the principal, interest, and description of collateral … it’s not really their fault.  It’s worked for a hundred years.  They don’t want to change, even if they could.

But as our economy evolves (for better or worse) into a post-industrial, knowledge-based system where small teams and individuals can survive and thrive on non-asset-intensive businesses … blah blah blah.  You get the picture.

New times call for new measures.  And we get to reinvent those measures, with help from our customers.  And since we have this new fancy thing called “COMPUTERS,” and we don’t have to rely on mimeographing a form that’s been around for a century, we’re not scared.  (In fact, we love creating product-market fit that resonates for our customers.  Nothing psyches us up more.)

VIII. Not for everyone, but a tool in the toolbox.

In sum, it remains to be seen whether folks like you, gentle reader, will agree with our point of view on Working Guarantees.  We might be full of shit on this one.  (We occasionally are.)

But if it works out, and if we can strike the right balance, we feel like this could be huge — a way to make a whole new category of businesses possible to finance.  In fact, we daresay that the Working Guarantee could usher in an era of Jeffersonian smallholding knowledge-farmers, prompting a new wave of entrepreneurialism, raising educational attainment rates, and thereby single-handedly conquering the recession and saving the economy.  But then we daresay a lot of stuff.

But long story short — please know that we promise not to bait-and-switch you, only to ask for a Working Guarantee if we think it’s the only way to get a deal done, and to be reasonable and flexible about how we do go about it.

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