A Personal Guarantee Changes How An Owner Sleeps

Item four on the agenda at a private oilfield services company in West Texas was the renewal of the bank line, and the board treated it the way a room treats an item that has been renewed every year since anyone could remember. The chairman owned the company and had signed the guarantee on the original line before most of the directors joined. When the vote was called he looked down the table and asked how a director ought to vote on a line the owner had put his own name behind. 'Rosser Newton,' he said to me in front of the other four, 'you tell me.'

Nobody spoke for what felt like a long time. The company was healthy, the lender was friendly and the renewal was routine, and I still watched three experienced directors look at their folders. They had all voted on that line before. None of them had ever been asked to think about whose house was on the other side of it.

This is for owners and chairmen of private energy service companies who carry a guarantee, and for the directors who sit beside them. I think the guarantee changes how the owner decides more than anything written into the loan agreement, and I think most boards behave as though it does not exist.

Does A Personal Guarantee Change How An Owner Decides?

Yes, and more than any covenant does. A covenant is a test the company passes or fails, and a guarantee is a debt the owner carries home.

The mechanics are plain enough. A guarantor is a person who answers for the borrower's obligation if the borrower cannot meet it, which makes him a secondary source of repayment for the lender. His liability arises only when the borrower fails to perform, so for years the guarantee can sit on a signature page and cost him nothing at all.

That is exactly why it works on an owner the way it does. The exposure is invisible in a good year and total in a bad one, and a man who has signed it plans for the bad one whether or not he says so in the meeting. A board can walk away from a bad year with the loss it has already taken. A guarantor cannot walk away from anything.

A renewal moves in a fixed order. The lender asks for financials, the owner supplies them, the credit committee at the bank reads them, a term sheet comes back, and the guarantor is asked to sign again. Every one of those steps passes through the owner before it reaches the board, which is why he knows the number first and why the board hears about the line as a finished thing.

You can see the difference in which decisions he makes alone. The directors bring a new crew, a larger rig or a customer who pays slowly to the table and argue it out. The guarantor tends to settle the ones that touch the line before the meeting, in his head, and bring the committee a conclusion that looks like a proposal.

Say the line is $6 million and the company draws $4 million of it in a normal quarter. A covenant tells the owner how far he can let the ratio slip before the lender calls. The guarantee tells him what the last $4 million costs him personally if everything goes wrong at once, and he will not take a decision the covenant allows if the guarantee would not.

I have watched an owner decline a job the board would have taken without discussion. The job was good and the crews were free. He declined it because the equipment had to be bought against the line, and the line was the one with his name on it.

What The Loan Agreement Does Not Show A Board

The loan agreement lists the financial tests, the reporting dates and the collateral. The guarantee is a separate document, often signed on a different day, and the board packet almost never contains it. The minutes of that meeting record that the line was renewed. They do not record that anyone read what the chairman had personally promised.

Directors in this position are not careless. They are polite, and politeness is how a guarantee goes unexamined for a decade. Nobody wants to be the first to ask a friend whether his house is on the paper, so the question waits for a bad quarter, which is the worst time to ask it.

I ask for three things at the meeting where a line comes up. I ask to see the guarantee, not a description of it. I ask what it covers, meaning the whole line or part of it, and whether the lender can pursue the owner before it pursues the company. I ask whether anyone else is on the paper, because a guarantee that a spouse also signed changes the conversation at home, and I would rather the board knew that than guessed.

An experienced director will push back on my next position, and I hold it anyway. When a line is guaranteed by the owner, the owner should abstain from the vote that sets how much of it the company will use, and he should say so before anyone asks. He is the one person in the room who cannot judge the risk as a director, because for him it is not shared.

The usual objection is that an owner who abstains has handed the room a decision it is not qualified to make. That is fair. Directors who have never signed one of these underweight the downside because their loss is limited to their seat. But a vote taken with the guarantor's thumb on the scale is a vote nobody can read afterward, and the minutes will show a unanimous decision that was really one man's.

I have argued before that choosing a lender means pricing the bad year, and the same reasoning applies one step earlier. The question is not only whether the lender will be there in the bad year. It is who is standing behind the lender's patience when the bad year arrives.

A board can walk away from a bad year and a guarantor cannot.

The practical form of this is small. Put the guarantee on the agenda once a year as its own item. Read the amount against the owner's own balance sheet, not the company's. Ask whether the owner would still want the line at that size if he had to sign it again today. The answer is sometimes a smaller line, and a smaller line that the owner can sleep on is better than a larger one he manages around.

Can A Guarantee Make An Owner Too Careful?

Yes. An owner whose guarantee has never been tested can drift toward turning down work a healthier company would take, because the downside is personal rather than corporate.

This is where my own rule breaks. I have spent a good part of this piece arguing that the guarantee deserves more attention than it gets, and the failure on the other side is just as real. An owner who thinks about it every night starts to price every decision as though the bad year were certain, and a company priced that way stops growing without anyone deciding it should.

I have told an owner to stop thinking about his guarantee. I told him the lender was friendly, the covenants were loose and the likelihood of a call was remote. I was wrong, and not because the call came. I was wrong because the thing he carried was not a probability. It was a weight, and telling a man to stop feeling a weight is advice he cannot use.

What helps, in my experience, is making the exposure smaller on purpose rather than making it easier to ignore. A guarantee limited to part of the line, a release written into the renewal once the company reaches an agreed point, a second source of repayment that spreads the risk across more than one signature. Each of these costs the lender something and the lender will price it, which is why an owner should ask while the company is strong and not when the line is under stress.

A reader who has signed one may take all of this as a lecture from somebody who is not on the paper, and he would have a point. I can describe how a room behaves around a guarantee. I cannot tell an owner what it feels like to sit at his table with it, and the owner's counsel is the right person to read the document with him, not me.

The headline number on a bank line is what the lender will say out loud. The guarantee underneath it is what the owner has agreed to carry, and those two have never been the same thing. Whatever an owner decides, it is his signature on the page, and nothing Rosser Newton writes will change that.

Photos by Nils Huenerfuerst and Aaron Burden on Unsplash

Sources

Guarantor, Legal Information Institute
Guaranty, Legal Information Institute