Personal Guaranties

Results

Dun and Bradstreet's Hoover database in October 2014, contained data on slightly more than four million incorporated small businesses in the United States. A confidence level of 95% with a margin of error of 5% for a four million targeted population requires 384. The investigation remained open on SurveyMonkey until 6,197 respondents had identified themselves as either the owner or a small business manager for the owner(s) to obtain the 394 completed responses for Question 8. 

The 6,197 respondents included a combined total of 1,462 respondents who owned or managed S and C-Corporations (Question 3). Question 4 of the survey was the first survey question focused on lending. Question 4 inquired, "Did your corporation have any loans during 2014, including any lines of credit that were in place but may not have been used during 2014?" Of the 1,462 respondents identified as an owner or manager of an S or C-Corporation, 17 respondents did not respond to Question 4, reducing the total respondents to Question 4 to 1,445. Of these 1,445 respondents, only 536 (37.09%) had any loans, including lines of credit, in place during 2014. 

20 of the 536 respondents with loans during 2014 were eliminated from the study because their corporations were publicly traded (Question 5). An additional 62 respondents were eliminated from the survey because the businesses involved one or more of the following industries: Agriculture, forestry, and fishing industry; Finance and insurance underwriting industry; or Real estate investment trusts industry (Question 6). The researchers eliminated 11 other corporations because they had more than 500 employees (Question 7). This filtering (elimination) process brought the total number of respondents meeting the targeted profile to 443. Of these 443 respondents, only 394 responded to Questions 8 and 9. Question 9 identified 204 of the 394 corporations that had at least one loan that required a guarantee. 

Table 1 lists the first eight survey questions and the corresponding number of respondents who responded to each of the first eight questions and the corresponding number of respondents eliminated from the survey as the questions filtered out those respondents who did not meet the targeted profile. Table 2 provides the demographic characteristics of the 394 respondents' small businesses.

Table 1: Summary of Survey Respondents for the First Eight Survey Questions

Table 2: Number of Businesses with Loans by Organizational (Legal) Form, Gender and Age Compared to Annual Revenue

Note: 11 of the 394 Respondents did not provide annual revenue in Question 17. 

Question 8 is the first question in the survey that seeks specific information on each of the five types of loans, the kind of collateral, and if a guarantee was required to obtain the loan. Additionally, Question 8 provides the respondents the choices of "Have this loan under other arrangements" and "Did not have this type of loan." The number of guarantees identified in Question 10 exceeded the number of guarantees identified in Question 8. Question 8 does not duplicate Question 10 other than requesting if various types of loans required a guarantee. Question 9 asked, "Did any of the loans in the above question require a guarantee?" Questions 8 and 9 do not request any identification of the source of the guarantee. A response of "Yes" to Question 9 then prompted the respondent to answer Question 10, "Please indicate below the source of the guarantee for each applicable loan type?" SurveyMonkey staff recommended using Question 9 to ensure the only respondents provided access to 10 had indicated their corporations were required to provide a guarantee for at least one of the loan types in Question 8. Question 10 is made available only by respondents, indicating in Question 9 that their corporation had a loan with a guarantee - question 10 collected data on the source of the guarantee for specific loan types. 

This study's Chi-Square analyzes used the responses to Question 10. Tables 7, 8, and 9 provide a breakdown of the number of S Corporations, C Corporations, and the combined total of S and C Corporations that provided personal guarantees for the five different loan types. Tables 3, 4, and 5 summarize the number of specific loan types that required personal guarantees by organizational form.

Table 3: Percentage of Loans by Type with Personal Guarantees in 2014 Held by Both S & C Corporations

Table 4: Percentage of Loans by Type with Personal Guarantees in 2014 Held by S Corporations Only

Table 5: Percentage of Loans by Type with Personal Guarantees in 2014 Held by C Corporations Only

Table 6 summarizes the percentages provided in Tables 3, 4, and 5 comparing the percentages of loans that required personal guarantees by loan types. 

Table 6: Percentage of Loans by Type with Personal Guarantees in 2014 by Organizational Form

Chi-Square Analyses

The researchers applied Chi-Square analysis for each type of loan for the three categories - S & C corporations, S corporations Only, and C corporations. Only to determine if the variation between the 1987 and 2014 percentages of loans with personal guarantees was significant. Tables 7, 8, and 9 have the results of the fifteen Chi-Square analyses. There is an increase in the use of personal guarantees in 14 of 15 comparisons. In 6 of these comparisons, the increase is statistically significant at the 5% level.

Table 7: Results of Chi-Square Analyses for Both S and C Corporations Combined, by Loan Type Between the Years of 1987 and 2014

Table 8: Results of Chi-Square Analyses for S Corporations Only, by Loan Type Between the Years of 1987 and 2014

Table 9: Results of Chi-Square Analyses for C Corporations Only, by Loan Type Between the Years of 1987 and 2014

Vehicle loans and "other loans" for S-Corporations showed statistically significant variation from 1987 until 2014. Equipment loans for C-Corporations showed statistically significant variation from 1987 until 2014. Three loan types have experienced statistically significant variation during 27 years for all corporations combined (S and C corporations) - equipment loans, vehicle loans, and other loans.

Findings from Questions 11 through 16

385 of the 394 Question 8 respondents whose corporations had loans responded to Questions 11, 12, and 13. The 385 responses to each of these three questions yield a 95% confidence level with a 5% margin of error when making inferences about the total population of incorporated small businesses located in the United States. These three questions focused on actions taken since 2008 by an incorporated small business owner who either decided not to provide a personal guarantee to obtain a loan or the lender declined (denied) a loan because of the corporate small business owner's inability to meet the lender's personal guarantee requirements. In response to Question 11, 48 (12.5 %) of 385 respondents indicated that their corporation decided not to undertake a positive net present value project because the lender required a personal guarantee. Question 12 identified that 42 (10.9%) of 385 respondents indicated their corporation had been declined (denied) a loan because of the owner's inability to meet the lender's personal guarantee requirements. Question 13 identified six (1.6%) of 385 respondents' corporations where the lender denied credit to the corporation because a minority shareholder refused to provide a personal guarantee. Question 13 regarding minority shareholders' stems from the Small Business Administration's (SBA's) 504 Loan Guarantee program. This SBA program requires all individuals holding more than 20% of the corporation's equity to provide a personal guarantee for all loans secured by the SBA. This SBA requirement places a burden on minority shareholders to execute personal guarantees when the minority shareholder is not in a control position. 

A response of "yes" to either Questions 11, 12, or 13 provided the respondent the opportunity to address Question 14, which focused on the impact of the incorporated small business owner not meeting the lender's personal guarantee requirements or the incorporated small business owner's decision not to provide a personal guarantee. While 15 (19.7 %) of the 76 respondents indicated no impact on their corporation, 40 (52.6%) of the 76 respondents indicated they had to seek funding elsewhere. 27 (35.6%) of 76 respondents indicated they could not pursue new products or services. 21 (27.6%) of 76 respondents indicated that their corporations had to forego an expansion project, and the same number of respondents indicated their corporations could not hire additional staff. 17 (22.4%) of the 76 respondents indicated their corporations had to lay off staff, and two (2.6%) of the 76 respondents indicated their corporations could not fulfill an order or contract. The small number of only 76 respondents does not yield a high level of confidence for making inferences about the total population of incorporated small businesses with loans located in the United States. 

Question 15 inquired if the respondent's corporation had ever refused to provide a personal guarantee to obtain a loan. A little over 15% (58) of the 383 respondents who answered this question indicated they had refused to provide a personal guarantee to obtain a loan. The 383 respondents are just below the 384 required responses to have a 95% confidence level with a 5% margin of error for making inferences about the total population of incorporated small businesses located in the United States with loans.

In response to Question 15, 58 respondents indicated they had refused to provide a personal guarantee to obtain a loan. Of that number, 55 responded to Question 16, pointing out that 23 (41.82%) of these 58 corporations still received a loan or credit from the same lender after refusing to provide a personal guarantee.

Summary of Findings

Incorporated small business owners with loans in 2014 provided personal guarantees to secure five different types of loans. Between the years of 1987 and 2014, the percentage of loans with personal guarantees from the incorporated small business owners, as reflected in Table 11, increased by 12.73%, 13.86 %, 56.36%, 121.85%, and 64.31% for lines of credit, mortgages, equipment loans, vehicle loans, and other loans respectively.

The importance of a dynamic and healthy Small and Medium-Sized Enterprise (SME) sector to developed and developing countries has been well documented (Wu & Zeng, 2008). Ang et al. (1995) recognized the existence of a lack of separation between business and personal risks for the owners of small businesses might limit and, in some cases, eliminate access to credit for small business owners with limited or no personal net worth. Restricted access to capital negatively impacts the current and future opportunities for owners of small businesses and for communities where small businesses operate. The importance of small businesses in the United States economy cannot be overstated (Berger & Frame, 2007). The U.S. House of Representatives House Committee on Small Business has identified access to capital for small businesses as a critical priority. Simultaneously, the Committee recognizes that small businesses employ more than 50% of the United States workforce, create two-thirds of new jobs, and generate more than 40% of the private sector's contribution to the gross domestic product (Small Business Committee, 2016).

The results of this survey documents that almost one out of every two loans held by the owner of an incorporated small business contains a risk-shifting mechanism, the personal guarantee. This risk-shifting mechanism effectively provides the lender access to the borrower's total net worth and future earnings in loan default. Coco (2000) noted that there might exist a gap between the entrepreneur's and the bank's valuation of the asset. Coco continued with, "In this case, the use of collateral, by increasing the riskiness of the return to the entrepreneur, provokes an inefficient risk allocation among the agents". Agents, in this case, referring to the lender and the borrower. The same holds on a loan with a personal guarantee. The incorporated small business owner's risk increases when providing a personal guarantee. The financial impact of the Great Recession is beyond the scope of this study. The Great Recession's financial impact on owners of incorporated small businesses continues to be experienced in many communities across the United States today. If one out of every two loans held by an incorporated small business contains a personal guarantee, there are many loans with potential inefficient risk allocation. Risk allocation in favor of the lenders, whom many argue today, contributed heavily to the Great Recession's root cause. 

The survey data finds incorporated small businesses in the United States are underleveraged. In 2014, less than 37% of incorporated small businesses had loans. In 1987, more than 67% of incorporated small companies located in the United States had loans. Modigliani and Miller (1958) declared that companies should maximize their capital structure's debt element to exploit the tax advantage realized through the interest expense deductibility. This decrease of more than 45% in the percentage of incorporated small businesses with loans between 1987 and 2014 should be of great concern to every member of the U.S. House of Representatives, House Committee on Small Business. 

This study has documented the occurrence of two of the four implications raised by Ang et al. (1995) that could exist or may occur due to the lack of separation between personal and business risk. Actions by owners of incorporated small businesses since 2008 support the following determinations. These determinations have a 95% level of confidence, with a 5% margin of error. First, an underinvestment problem exists as 12.5% of owners of incorporated small businesses with at least one loan have decided not to undertake a positive investment opportunity (positive net present value project) because the lender required a personal guarantee. Closer analysis of this particular data shows that half of the 12.5% of S and C Corporations were greater than 20 years of age. 22.2%, 27.6%, 18%, 13.87% of corporations with a business age of 3 to 5 years, 6 to 10 years, 11 to 20 years, and greater than 20 years respectively decided not to undertake a positive net present value investment because the lender required a personal guarantee. 

Second, lenders have denied a loan to 10.9% of small business corporations with at least one loan resulting in credit rationing because of their inability to meet the lender's personal guarantee requirements. This 10.9% of S and C Corporations included 13.7% of corporations with 1 to 9 employees, 24.5% of corporations with 10 to 19 employees, and 12.5% of corporations with 20 to 49 employees. Lenders have not denied S and C Corporations with 50 to 250 employees and 251 to 500 employees a loan because of their inability to meet the lender's guarantee requirements. 

This study also identified an occurrence of immediate importance to owners of incorporated small businesses seeking loans. Of 58 corporations that refused to provide a personal guarantee when requested by the lender, 23 (39.7%) still received financing from the same lender. The percentage that still received a loan varied by gender. Only 22.2% of female respondents still received the same lender loan after refusing to provide a personal guarantee compared to 51.4% of male respondents. This high percentage of lending demonstrates that lenders sometimes request personal guarantees when they are willing to make the loan without a personal guarantee. No corporations under five years of age received the loan after refusing to provide a personal guarantee.