Buying a franchise: limit your personal guarantees

When you join a franchise network, you are responsible for your own company’s financing and obligations. If a lender, landlord or franchisor asks for a personal guarantee, the company’s financial difficulties can also affect your personal finances. Review guarantees together before buying: comparing loan amounts or monthly repayments alone will not reveal the extent of your personal risk.

1. List all your personal liabilities in one place

A limited company’s debt and an entrepreneur’s personal guarantee are separate matters. As a rule, a shareholder in a Finnish limited company is not personally liable for the company’s obligations, but signing a guarantee can create that liability. Do not assume that your private assets are protected in every situation simply because you operate through a limited company.

Before signing, ask to see all guarantee and security documents, as well as the financing decision. Also check the schedules to the franchise agreement, the lease and any equipment finance agreements. An undertaking that creates personal liability may be in a separate document or form part of another agreement.

Create a table with a separate row for each liability:

• Creditor: to whom are you liable for the company’s debt?
• Principal debtor: which company’s obligations does the undertaking cover?
• Debt covered: is it a specified loan or a broader range of current and future obligations?
• Maximum liability: what is the financial cap, and does it include interest and costs?
• Release: on what terms does your personal liability end?

Also distinguish a guarantee from a third-party pledge, where you provide your own assets as security for someone else’s debt. These have different legal effects. Ask a specialist to establish whether your exposure is limited to particular assets provided as security or whether you have a personal obligation to pay.

2. Understand the legal basis of the guarantee

Finland has no separate franchising act, statutory franchise disclosure document or special registration procedure for franchise agreements. Agreements within a franchise network are governed by general legislation, including the Contracts Act, the Competition Act and the Unfair Business Practices Act. The key legislation for guarantees is the Act on Guarantees and Third-Party Pledges.

The type of guarantee affects when the creditor can demand payment from you. Under a guarantee payable as for one’s own debt (omavelkainen takaus), the creditor can generally demand payment from the guarantor once the principal debt falls due. The creditor does not first have to establish that the debtor is insolvent. A secondary guarantee (toissijainen takaus) works differently: additional conditions specified by law must be met before the guarantor can be required to pay.

The guarantor’s status also affects the protection available. A ‘private guarantor’ under Finnish guarantee law is not simply any individual. For example, a guarantor who is part of the company’s management or ownership may fall outside that definition. Do not assume that you have all the rights protecting private guarantors merely because you sign in your own name.

Under the Contracts Act, an unreasonable term may, in certain circumstances, be adjusted or disregarded. However, you should not base your risk management on that possibility. The Finnish Franchising Association’s Code of Ethics is a form of industry self-regulation, not legislation or automatic protection against liability under a guarantee.

3. Negotiate limits before accepting the financing

The need for a personal guarantee and its terms are determined case by case. Separate three questions during negotiations: which debt you are guaranteeing, how much you could have to pay, and for how long the undertaking can cover new obligations.

Aim to define the debt covered as precisely as possible. A guarantee securing a specific loan is easier to assess than an undertaking covering a broad range of the company’s obligations to the same creditor. In particular, establish whether a guarantee given to the franchisor also covers contractual penalties, damages or charges other than standard franchise fees.

Negotiate and record in writing at least the following:

• The maximum liability in euros, including how interest and recovery costs are treated.
• Whether your liability reduces as the loan is repaid.
• The procedure if the loan amount, repayment period or other terms change.
• Whether you can later replace the personal guarantee with other security.
• The precise conditions for release from the guarantee.

If there are several guarantors, also establish whether the creditor can demand the entire debt covered from a single guarantor. An agreement between shareholders on sharing liability does not, in itself, restrict the creditor’s rights. Nor does a possible right to recover contributions from other guarantors mean that they will have the money to pay.

A guarantee from Finnvera, Finland’s state-owned specialised financing company, may help you obtain bank financing in suitable circumstances. However, it does not cancel the company’s debt or automatically release you from requirements to provide personal guarantees or assets as security. Ask the bank for a written explanation of the full security arrangements and their effect on your own liability.

4. Test what happens if the business fails or you leave

Calculate your personal exposure if the business closes earlier than planned. Consider loan guarantees, lease liabilities and other undertakings together. A guarantee that looks acceptable on its own may create excessive risk when combined with other liabilities.

Do not treat the current value of assets provided as security as a guaranteed safeguard. Establish how the outstanding debt and any proceeds from realising that security affect your remaining liability under the guarantee. Separately assess how you would fund a personal payment if you no longer had income from the business.

Selling the business, giving up your shareholding or ending the franchise agreement does not, in itself, release a guarantor. Agree on the release procedure at the outset. When your liability is due to end, obtain explicit written confirmation from the creditor. A buyer’s promise to take over the liabilities is not enough on its own to change the creditor’s rights.

Practical checklist: do not sign until you can identify the creditor, the debt covered, the maximum liability and the release conditions for every guarantee. Have any unclear undertakings reviewed by an independent lawyer, and assess the overall risk to your household finances too.