Buying a franchise: limit your personal guarantees

When joining a franchise network, it is easy to focus on the initial fee and the business loan. Yet what matters most for your personal finances may be what you agree to pay personally if the business cannot meet its obligations. Both the lender and the franchisor may require guarantees to secure amounts owed to them. Reviewing those guarantees should therefore be part of your risk assessment when buying a franchise, not something left until you sign the loan documents.

1. Separate the company’s debt from your own liability

In Finland, a limited liability company (osakeyhtiö) is a legal entity separate from its owners, and shareholders are generally not personally liable for its debts. That protection does not, however, cover debt you have personally guaranteed. For a sole trader (toiminimiyrittäjä), there is no equivalent distinction between business and personal liability for debts.

A personal guarantee is an undertaking to answer for someone else’s debt. Third-party pledging, by contrast, means providing assets as security for someone else’s debt. If you pledge your own assets as security for your company’s loan, those assets may have to be sold to repay it, even if you have not given a personal guarantee. The documents may contain both arrangements.

Do not confuse a guarantee with being a co-borrower, either. If you sign a loan agreement as a borrower alongside the company, you are not merely providing security: you are taking on a debt obligation of your own. Ask the lender to show you the capacity in which you are signing each document.

Also review the signature sections in the franchise agreement and its schedules. Signing on behalf of the company is different from giving a separate personal undertaking. An owner’s personal liability required by the franchisor can easily go unnoticed if it appears at the end of the agreement or in a separate security schedule.

2. Understand the rules that apply in Finland

Finland has no specific franchising act, statutory registration system for franchise agreements or franchise-specific requirement for a standard pre-contractual disclosure document. Agreements are governed by general legislation, including the Contracts Act, the Unfair Business Practices Act and, where relevant, the Competition Act and the Trademarks Act.

Guarantees and pledges securing another party’s debt are governed by the Act on Guarantees and Third-Party Pledges (361/1999). It includes provisions on matters such as the scope of liability under a guarantee and the guarantor’s position. How the Act applies depends on the undertaking and the status of the parties. Simply signing as an individual does not mean you receive all the statutory protections available to a private guarantor: your position as a director, manager or owner of the debtor company, for example, may affect this.

Under the Contracts Act, an unreasonable contractual term may be adjusted or set aside. This is not a safe fallback for an overly broad guarantee. Any dispute will be assessed on its own facts, and the failure of the business does not in itself extinguish the guarantee.

Franchising codes of ethics are not law and are no substitute for reviewing the guarantee itself. Check separately whether they apply, but always assess your own liability on the basis of the terms you will sign.

3. Look beyond the euro amount in a guarantee

The heading on a guarantee does not reveal the full risk. Under a Finnish omavelkainen takaus, often translated as a guarantee as for one’s own debt, the creditor can demand payment from the guarantor once the principal debt falls due, without first establishing that the debtor is insolvent. A secondary guarantee has different conditions for triggering payment liability. Ask for an explanation of the practical effect of the particular undertaking you are being offered.

Review each guarantee using the following questions:

• Which debt does the guarantee cover? A specific loan, or the company’s existing and future obligations more broadly?
• What is the true maximum liability? Are interest, default interest and debt collection costs included within the cap, or can they be added on top?
• How long does liability last? Distinguish between the period during which new debts can fall within the guarantee and the point at which liability for debts already incurred ends.
• Which changes does the guarantee cover? Check the effect of additional borrowing, extensions to repayment periods and other changes to the debt terms.
• What happens if ownership changes? Selling the company or stepping down from management may not release you from liability.

If there are several guarantors, do not assume your liability is limited to your ownership share. Your liability to the creditor may be wider than the agreement between the business owners suggests. The allocation of liability between guarantors, and any right to recover payments from others, must be assessed separately.

4. Negotiate limits as part of the overall package

Before committing, draw up a list of all guarantees and security arrangements. Record the creditor, debtor, person providing the security, what the security consists of, the maximum liability and the conditions for release. Include not only the bank loan but also undertakings given to the franchisor and any security for equipment or supplier finance.

This will help you spot whether the same personal assets underpin several arrangements. A modest cap on one guarantee does not reveal your total exposure if you have other liabilities alongside it. Also consider your household’s ability to meet its bills: how would you pay for housing and essential expenses if your income from the business stopped at the same time as a guarantee was called upon?

Possible negotiating objectives include limiting the guarantee to a specific debt, setting a clear overall cap and reducing your liability as the loan is repaid. You could also propose written release criteria based on an agreed level of outstanding debt or the provision of replacement security. The creditor does not have to accept your proposals, but it is worth exploring their costs and benefits.

A guarantee from Finnvera, Finland’s state-owned financing company, may form part of the business funding package, but do not assume it removes the need for personal security. Check the current terms in both the bank’s and Finnvera’s financing decisions. Even with state-backed finance, it is the overall package that matters.

5. Get written confirmation of your release

Plan how your liability will end before buying the franchise. The expiry or termination of the franchise agreement, closure of the business or sale of the shares does not automatically bring all guarantees to an end. Agree who will request the release and at what stage the creditor’s approval is needed.

Keep signed undertakings, amendments and release notices together. Review the security arrangements whenever additional finance is taken out or ownership changes. A verbal promise of a later release is no substitute for written confirmation from the creditor.

Practical reminder: do not sign until you can explain in your own words what you are liable for, how much you could have to pay and the conditions under which your liability ends. Have any unclear provisions checked by an independent lawyer before committing.