Personal Guaranties

Research Methodology

This study focuses on determining changes in the demand for personal guarantees from owners of incorporated small businesses by lenders during a 27 year period, beginning in 1987 and continuing through 2014. This study has a three-fold purpose. The first is to increase awareness of the differences between business collateral and personal commitments, and between personal collateral and personal guarantees. The second is to document the current demand for personal guarantees by owners of incorporated small businesses for various loan types, categories, and uses, such as lines of credit, mortgages, equipment loans, vehicle loans, and "other loans". The third is to determine if it is possible for an incorporated small business owner to receive a loan from the same lender after refusing to provide a personal guarantee. 

This study responds to a recommendation by Mann to continue Avery, Bostic, and Samolyk initial efforts as more data sets become available and limit the review only to incorporated firms. This study builds on specific aspects of Ang et al.'s  research into the use of personal commitments by small business owners, which was continued by Avery et al. Ang et al. used 692 firms' data from the 1987 NSSBF to identify those small business owners, including S- Corporations and C-Corporations, who had a significant incidence of personal assets and wealth pledged for business loans. They confirmed a lack of separation between business and personal risks, even for incorporated small commercial entities. Avery et al. used the 1993 NSSBF to determine that guarantees are more prevalent than collateral and that organizational type, such as corporation versus sole proprietorship or partnership, is linked to commitment use. They point out that lending agencies know little about how personal commitments relate to financing arrangements in practice, despite the potential for personal commitments to affect which loans small firms receive. Avery et al. identified a lack of available data sets containing detailed information about personal commitments (collateral and guarantees) in small business finance as one reason for limited academic literature. They further identified that the few data sets available aggregate all collateral, making no distinctions between business versus personal collateral and provide no information on guarantees. 

Initially, this study was planned as an extension of the Avery et al. research, expanding the analysis to include data collected during the 1998 and 2003 SSBF. Between the 1993 NSSBF and the 1998 survey, the Federal Reserve Board renamed this series of investigations by dropping "National" from the title, and therefore, the last two surveys of the series are titled "Survey of Small Business Finances". Avery et al. used the 1993 NSSBF to identify trends in the role of personal wealth in small business finance in comparison to data collected during the 1987 NSSBF. They noted that, of particular interest to their study, the NSSBF is the only public data source that identifies if and how small business loans are collateralized and if and by whom each loan is guaranteed. Unfortunately, the 1993 NSSBF, unlike the 1987 NSSBF, did not collect any data on the source of the guarantee. The 1993 NSSBF only collected data on the use of a guarantee. In Footnote 14 of Avery et al. (1998), they provide the following: 

It is noteworthy that, while imputing the percentage of loan guarantee sources based on the loan type, for 1993's data, there was an increase from 1987's data in the number of guarantees in general.

Both the 1987 and 1993 NSSBF asked if a cosigner or another guarantor was required to get credit line(s), mortgage(s), equipment loan(s), vehicle loan(s), or other loans. The 1987 Survey included the following: 

Questions B13 (credit lines), B20 (mortgages), B27 (motor vehicle loans), B34 (equipment loans), and B41 (Other Loans – specifically, loans from partners/stockholders) asked, "Was a cosigner or guarantor required to get (this/any of these) (type of loan)?" Questions B14, B21, B28, and B35 asked, "Were these cosigners or guarantors….a. Owners? b. other individuals or business firms? c. the Small Business Administration? d. another government agency? e. some other source?" The available responses were Yes, No, Don't Know and Refusal. Question B41 only provided two choices for the guarantee – a. owners and b. other individuals or business firms. 

The 1993 NSSBF changed the wording from 1987, and questions F14 asked, "Was a personal guaranty, cosigner, or other guarantor required to obtain any line of credit at (Name of Lender)?" Questions F26 (mortgages), F31 (motor vehicle loans), F36 (equipment), and F47 (other loans) asked the same question for the specific loan type. No follow-up question collected data on the specific source of a guarantee. The 1998 SSBF and the 2003 SSBF used the same question format as the 1993 NSSBF, not collecting any data on the specific guarantee source. 

The 1998 and 2003 SSBF also collected data regarding whether a guarantee, by either a cosigner or other guarantor, was required to get credit line(s), mortgage(s), equipment loan(s), vehicle loan(s), or other loans. The 1998 and 2003 SSBF, just like the 1993 NSSBF, did not collect any data on the exact source of the guarantee. Only the 1987 NSSBF collected detailed data on the source of any guarantee by inquiring, "Were these cosigners or guarantors ……a) owners, b) other individuals or business firms, c) the Small Business Administration, d) another government agency or, e) some other source?" (Federal Reserve Board, 1987, Survey Questions B14, 21, 28, 35, 42 and 52). 

Mann(1998) had credibility issues with Avery et al. (1998) provided data and its methodology. Mann's position is that Avery et al. had understated the demand in 1993 for personal guarantees from incorporated small business owners for each of the loan types. This understatement identified by Mann in Avery et al. for the requirement of personal guarantees in 1993 could be a direct result of the 1993 NSSBF's dropping the question related to identifying the guarantee's source. 

A review of 39 published academic articles that reference Avery et al. (1998) confirmed no research had conducted the specific recommendations made by Mann, to focus only on the incorporated firms for future data sets, which would be the investigations for 1998 and 2003. 

Mann (1998) found the Avery et al. (1998) study's most essential aspect: it was the first attempt to provide any empirical data about small business owners' personal financial strength in the underwriting of small business loans. Mann (1998) acknowledged that while this may not seem to be of any importance to the casual observer, underwriting changes had made this crucial for banks in the small-business finance market. Mann (1998) had a high level of interest in the work of Avery et al. because during the same general period, Mann (1997a & b) was exploring the use of secured versus non-secured credit for both large and small businesses. Mann (1998) considered the research accomplished by Avery et al. (1998) to be significant and supportive of his positions on the growing demand for the personal guarantee with one exception. He noted that the percentage of loans held by small corporate business owners supported by a personal guarantee was much lower than Mann (1997b &1998) had anticipated. A discussion between a researcher of this study and Mann identified that Mann (1998) did not realize the 1993 NSSBF did not include the collection of guarantee source and that Avery et al. had used imputed values from the 1987 NSSBF. 

Mann (1998) considered the data used by Avery et al. (1998), pulled from both the 1987 and 1993 NSSBF, to be the best data available for this type of study. However, based on the rapid changes in the banking industry, specifically with small business underwriting, Mann considered the 1987 and 1993 data to be relatively outdated for studying personal guarantees in 1998. Without an awareness of the deletion of guarantee sources' collection, Mann recognized the 1998 SSBF data set upcoming release. He thought the 1998 SSBF data would provide a much more accurate insight into the personal guarantee's actual demand level. 

Mann (1998) referenced that in an earlier document (1997b), he had already indicated that underwriting changes since 1993 had a high probability of altering collateral and guarantee usage in small business lending throughout the 1990s. He further indicated that he hoped that Avery et al. (1998) would continue their ongoing work by updating their findings as future data sets become available. Mann (1998) considered the personal guarantee to be even more critical than Avery et al. suggested. 

Mann (1998) made two suggestions on how to best approach analyzing the use of personal guarantees. He suggested that the reviewer examine loans made to firms where the firm's legal, organizational form prevents the small business's principals' personal liability. Secondly, they should assess only the loans in which principals of the borrower provide personal guarantees, and, in doing so, agree to accept personal liability for the loan. 

A search for published academic articles referencing Avery et al. (1998) did not identify any researchers who had undertaken the Mann (1998) recommendation. The review did identify, however, Cole (2013), who used the 1987 and 1993 NSSBF, and the 1998 and 2003 SSBF to examine the capital structures of privately-held U.S. firms. Cole speculated that small corporate companies' median leverage ratios would be the same as those used by proprietorships if personal guarantees were required. Cole contended that if the median leverage ratios for incorporated entities are higher than the median leverage ratios of sole proprietorships, owners of incorporated small businesses have not given up their limited liability by executing personal guarantees. When Cole found that proprietorships use far less leverage than incorporated small businesses, she concluded that most owners of incorporated small businesses are not required to provide personal guarantees. This study will validate Cole's assertion or show that Cole came to an incorrect linkage between median leverage ratios and organizational types to conclude personal guarantee usage.

Research Question

The overarching research question is: Between 1987 and 2014, did the demand for personal guarantees from owners of incorporated small businesses increase for various loan types? Five different loan types will be examined in this survey: lines of credit, mortgages, equipment loans, vehicle loans, and other loans. Fifteen testable hypotheses in this study are as follows: 

H₁₀: Personal guarantees did not increase in usage for owners of incorporated small businesses, including both S and C-Corporations for lines of credit between 1987 and 2014. 

H₂₀: Personal guarantees did not increase in usage for owners of incorporated small businesses, including both S and C-Corporations for mortgages between 1987 and 2014. 

H₃₀: Personal guarantees did not increase in usage for owners of incorporated small businesses, including both S and C-Corporations for equipment loans between 1987 and 2014. 

H₄₀: Personal guarantees did not increase in usage for owners of incorporated small businesses, including both S and C-Corporations for vehicle loans between 1987 and 2014. 

H₅₀: Personal guarantees did not increase in usage for owners of incorporated small businesses, including both S and C-Corporations for other loans between 1987 and 2014. 

H₆₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for S-Corporations for lines of credit between 1987 and 2014. 

H₇₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for S-Corporations for mortgages between 1987 and 2014.

H₈₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for S-Corporations for equipment loans between 1987 and 2014. 

H₉₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for S-Corporations for vehicle loans between 1987 and 2014. 

H₁₀₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for S-Corporations for other loans between 1987 and 2014. 

H₁₁₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for C-Corporations for lines of credit between the years of 1987 and 2014. 

H₁₂₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for C-Corporations for mortgages between 1987 and 2014. 

H₁₃₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for C-Corporations for equipment loans between 1987 and 2014. 

H₁₄₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for C-Corporations for vehicle loans between 1987 and 2014. 

H₁₅₀: Personal guarantees did not increase in usage for owners of incorporated small businesses for C-Corporations for other loans between 1987 and 2014.

Survey Instrument

The researchers used the 1987 NSSBF to identify the loan types included in the survey for this paper (i.e., lines of credit, mortgages, equipment loans, vehicle loans, and other loans). Avery et al. (1998) noted that the 1987 NSSBF collected data for for-profit, non-agricultural, non-financial firms with fewer than 500 full-time equivalent employees. The organizations reviewed in the 1987 NSSBF consisted of a nationally representative sample of small businesses operating in the U.S. as of the last day of each survey year. 

This study includes a survey of small business lending focused on personal guarantees provided by owners of small incorporated businesses located in the United States. The survey focuses on 1987 NSSBF loan types and guarantee sources to allow for a comparison between the 1987 NSSBF data and the data collected during this study. One significant change in this new study is that this study has a much narrower scope than the 1987 NSSBF. The 1987 NSSBF included other lending issues throughout the U.S. in addition to the demand and source of guarantees. Additionally, the 1987 NSSBF collected data via telephone interviews. 

The final survey format went through a multiple phase development consisting of three pilot surveys. The pilot surveys, without a doubt, contributed heavily to the quality and effectiveness of the final questions. SurveyMonkey was used to conduct data collection during April and May 2015 using its SurveyMonkey Audience service.