Imagine for a moment that someone approaches you and asks if you would be willing to lend them money. They proceed to tell you all about the venture and the enormous amounts of money they are going to make as a result of securing money from you in the form or a mortgage or loan. They continue to tell you that notwithstanding nobody knows the future, their venture is a sure bet guaranteed to make them profit and riches beyond their wildest dreams and all they need is a loan or mortgage from you to make it all happen.
As you try to drink from their fire-hose of ideas and optimism you begin to ask some questions about security. How will the money be secured? Are there any assets available for collateral? If there are assets available, have they already been pledged to other people for other loans and/or mortgages? You then learn that most of the assets owned by this person are already leveraged but there is a little bit of equity remaining that they would pledge to you in exchange for you putting up the money. Then you ask the question most borrowers recoil at:
“Would you be willing to give me a personal guarantee?”
Then a verbal diatribe is unleashed as your request appears to be totally misplaced and unnecessary. They proceed to remind you how great the venture will be and how much money will made and the fact that they will have “no skin in the game” is an obvious fact that slides right past them. In their mind your money is safer with them in the venture than it would be in anything else. It doesn’t matter that the interest rate you will charge for your money will be fixed and their profit potential is unlimited, they get their back up at the thought of having to provide a personal guarantee. In the course of being upset they end up relaying to you a very important piece of information – they don’t believe in what they are doing as much as their words would indicate they do. That’s a problem.
Non recourse lending is when a bank or lender has no ability to pursue the borrower for any losses incurred outside of the original assets pledged for a mortgage or loan. In my experience banks and lenders do not get very excited about providing funds to borrowers that are not willing to provide guarantees. Corporate guarantees from related companies, personal guarantees from the principals of a company or other parties are all necessary for a bank or lender to ensure that the borrower has a vested interest in seeing a loan or mortgage repaid. There are exceptions but they are few. When we hear a borrower get up in arms about providing personal guarantees we will most times let them know that we won’t be able to help them.
An important point to remember is that guarantees can be limited. A bank or lender may be prepared to accept a partial personal guarantee that is not equal to the loan or mortgage amount and is not unlimited. If a borrower has a strong financial foundation they may have some negotiating power with a bank or lender to have the guarantee coverage reduced.
So if you find yourself in a situation where you are being asked to limited your return in the form of a fixed interest rate while the person asking for money stands to receive unlimited profits (and losses) but is unwilling to provide a guarantee, think carefully about doing the deal. I heard it once said:
“The best money I never lost was the money I never invested”