There’s a lot of bad startup advice in the world. In fact, Hunt & Kiefer have shown that the more startup advice entrepreneurs ingest, the less likely they are to succeed. Advice givers tell entrepreneurs dumb stuff like “do more faster” and “hustle harder” all the time. I think lots of this advice is misguided, but not necessarily malicious. More often than not, this bad advice is the product of laziness.
My willingness to ascribe bad advice to laziness rather than malice hits its limit, however, when it comes to what I think is the single most corrupt piece of advice investors give to entrepreneurs – advising them to personally guarantee their startup. I was talking to an old friend about a fundraising round the other day when I realized I was shouting into the phone, my heart rate was through the roof, and I was incredibly angry. Before I let him off the phone, I made him promise me that he would call me before he thought about doing something as stupid as personally guaranteeing a loan. Why did it make me so mad?
First of all, I think personally guaranteeing a loan has a certain time and place. If your only source of capital is debt capital from a bank or the SBA, it might make sense to take out a loan that you guarantee personally. This can be particularly true for brick and mortar businesses where you have a reasonable certainty of cash flow or profitability in the foreseeable future. I took SBA loans that required a personal guarantee to open pizza restaurants for instance, where our future revenue was relatively predictable. Proceed with caution, but there is a time and place for this tool.
But if you’re running a growth company where you have already taken outside capital, personally guaranteeing anything should be off the table the minute you raise from investors.
There are lots of mathematical and philosophical reasons I feel so strongly about the principle, but the one I found myself telling my friend was emotional in nature. Simply put, shutting down a company is an absolutely miserable experience. The darkest period of my life, the time that I wondered if I wanted to continue, came while I was in the process of putting a corporate entity through bankruptcy. It was heartbreaking and depressing beyond words.
As that happened, I had creditors trying to collect on corporate debts through all sorts of shady and illegal tactics. Some spoofed friends of mine on caller ID. Others threatened to make my life miserable for years. Creditors that verbally agreed to take a portion of the payoff would then renege and demand more. A landlord held my employees’ personal belongings in the office hostage trying to collect more money.
I got to the point that I didn’t want to answer my phone or look at my email.
I don’t necessarily blame the collectors. They have a job to do, and I was embarrassed beyond words that I didn’t have the money to repay what my company owed. But, my experience is that the human beings who focus on debt collection tend to not be terribly empathetic or ethical. They use every tool at their disposal to make life miserable, and extract every cent they can. My only saving grace was that I didn’t ever personally guarantee anything. I don’t even want to imagine going through that process or my emotional state if they had a right to come after all of my belongings. The already hard conversations with my fiancee would have been excruciating. The hole I needed to dig myself out of would have been much deeper.
Taking a personally guaranteed loan may sound like a great idea to your investors. It’s cheap and non-dilutive capital. Unfortunately, investors are all too willing to encourage entrepreneurs to load up with as much risk as possible if it means that it might improve the investor’s IRR. If you want to see what they really think of this idea, ask them to put some skin in the game and personally co-sign the loan with you. Watch how fast they come up with excuses for why they shouldn’t take on the risk they are trying to foist upon you.
Remember that 75% of even venture backed startups fail. Behind every one of those failures is a story of heartbroken and emotionally broken entrepreneurs trying valiantly to extricate themselves from a challenging situation while retaining some modicum of dignity. Putting the money aside, that emotional hell is one that you don’t want to live through, and is exponentially worse if your creditors can come after your personal assets in addition to the corporate ones. Take it from someone who has been through the downside scenario, don’t ever personally guarantee your startup.