Why do you need to sign a personal guaranty?

Why do I have to sign a Personal Guaranty?!

When you consider buying into a franchise, you receive hundreds of pages of disclosures and contracts. Most likely, there is a personal guaranty somewhere in that huge PDF. It’s important to understand what a personal guaranty is and why most franchisors require that you sign one.

A personal guaranty is a promise to pay the debt or fulfill the obligation of another if that person or entity fails to do so. In franchise deals, almost every franchisee signs a franchise agreement as an entity. John Doe creates John Doe, LLC and signs the franchise agreement on behalf of John Doe, LLC instead of in his individual capacity. However, the franchisor requires John Doe to sign a personal guaranty. By signing this, John Doe is saying that he will pay any debts or fulfill any obligations that John Doe, LLC fails to pay or perform. Yes, this grants the franchisor access to John Doe’s personal assets in the event his franchise venture goes south. This concept is scary to most franchisees, but it’s important to think about this from the other side of the deal.

If a franchisor didn’t require a franchisee to sign a personal guaranty, that franchisee could virtually do whatever he wants and exit the system upon a whim. Imagine that John Doe, above, buys into and opens up a childcare franchise. Let’s say that the franchisor didn’t require him to sign a personal guaranty. Everything’s going great in Year Three of John Doe’s term, but he thinks he could make a ton of money selling craft beer in his community. He decides to start brewing beer in one of his classrooms and opens up a pub on the back patio of the daycare. John Doe quickly gets a notice of default from the franchisor, because that’s a breach of several portions of his franchise agreement. John Doe transfers all of the assets out of his LLC and sends the franchisor a notice of termination, and continues operating his daycare-brewery.

Now, the franchisor can get a judgment against John Doe, LLC that it can’t execute because John Doe, LLC has no assets! The franchisor can’t go after John Doe individually because he never signed a personal

guaranty. Now, the franchisor is stuck with a damaged brand, a terminated franchisee, a host of administrative and legal fees, and probably the cost involved with getting a new franchisee in that territory.

If John Doe had signed a personal guaranty, his feet would be held to the fire. He would then be personally responsible for making sure that he, through John Doe, LLC does not breach the terms of their franchise agreement. It’s amazing how compliant someone can be when his personal assets are at stake.

The bottom line: A personal guaranty is a tool for ensuring franchisees have skin in the game. Requiring a personal guaranty to be signed by the individual owner of a franchisee entity and his spouse is the industry norm. In the 300+ FDDs I’ve reviewed for prospective franchisees, I’ve never not seen a personal guaranty in a franchise deal. While it’s something every prospective franchisee needs to consider in his risk analysis, it should not be a surprise or a deal breaker.

And by the way, if anyone wants to start a daycare-brewery franchise, call me!

Jonathan Barber exclusively practices franchise law as a partner at Barber Power Law Group, in Charlotte, North Carolina. He has assisted hundreds of clients world-wide with their FDDs and franchise purchases. Barber also represents emerging and established franchisors. Contact Barber at 980-202-5679 or JBarber@barberpowerlaw.com.

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