Co-signing is a common practice in the world of financing, but there are aspects of it that can seem a little fuzzy. We’d like to bring some clarity to the subject.
What Is Co-Signing?
Lenders typically want to reduce risk and increase security on any lending agreement. (See The Reality of Equipment as Security.) They want to be assured that the money they have credited will be paid back.
If something happens to the borrower, how will the payments be made? Who will be responsible for paying out what’s left owing?
Adding a co-signer to a lending agreement gives the lender additional security. It gives the lender an extra layer of protection and reduces the risk of losing their money should the primary borrower become unable to pay it off. When you become a co-signer, you are promising to pay off the debt if the primary borrower is unable to (for whatever reason).
When Is Co-Signing Required?
In any situation where a lender doesn’t have enough security or assurance of the borrower’s ability to pay out the financial obligation, a co-signer will be required.
Common instances are:
- the borrower doesn’t have a strong credit rating,
- the borrower doesn’t have a lot of industry or business experience,
- the borrowing company is not making a lot of money, or
- the borrowing company is just starting up.
Who Can Co-Sign?
In the world of lending, a business is considered its own entity – like an individual person. If the company isn’t strong enough to be the sole borrower on a lending agreement, a co-signer will be required. Generally speaking, it’s good if the co-signer has some sort of ownership interest in the company. A co-signer is often the business owner, a business partner, or a family member of the business owner.
What Should I Know Before Co-Signing?
Before you agree to co-sign on any financial agreement, you need to be sure you understand:
- Who you are co-signing for (either an individual or a company): Do your research before agreeing to cosign for anybody. This goes for family, friends and business partners. Keep in touch with the person or company you’re co–signing for so that you know what’s going on and where things are at financially.
- How much you are co-signing for: Know the exact terms of the contract, what will be owed and when.
- The legal obligations outlined in the contract: Read the fine print.
Co–signing is not unusual in the lease financing process. It is as common as a parent co–signing a child’s car loan. (In that case, you know that if your child can’t make the payments, you will have to.) In the case of a newer business or if you as a business owner usually take the profits out of your company, lenders are most likely going to ask you to co-sign. Their view will likely be that if you don’t believe in your company, why should they?
Co-signing is not always a negative thing. Yes, there are implications and ramifications. But the flip side is that leases don’t go on forever. It is a temporary arrangement. Typically, a lease agreement is 3 to 5 years.
What Happens If The Primary Borrower Doesn’t Make The Payments?
If the person or company you’re co–signing for is unable to make their payments, you do have the option to pay out the balance of payments and do whatever you want with the equipment.
People sometimes get nervous about co–signing because they are afraid lenders could come after them and make them sell their house, for example. Even though, as a co–signer, you are legally responsible for ensuring the financial obligation is fulfilled, it’s also important that you understand the limitations on the part of the lender.
A lender does not have unlimited power if something goes “sideways” with the lease. If something happens that forces them to take the equipment back, they will sell it and look to the co–signer to make up any shortfall, past due interest, legal fees, or any other costs they’ve incurred in order to realize on the lease (such as bailiff fees if the lessee makes it difficult for them to pick up the equipment, for example). (Again, see The Reality of Equipment As Security.) There is a limit to what they can come after. If you only owe them $10,000, they can’t come after you for $1,000,000. It’s not “carte blanche”.
So a co–signer is legally responsible for the shortfall but only according to the terms of the lease.
A Special Note to Business Owners & Sole Proprietors
It is important to understand that an incorporated company is a stand-alone entity legally speaking. The owner may be asked to co-sign for the company as if it were another person. However, if you are a sole proprietor, know that you are the company. Your company is not a separate legal entity. Therefore, you are personally responsible for the debt. You may be asked for a co-signer if your credit is not strong enough.
Sometimes business owners think that a loan through their corporate bank does not hold them personally responsible. This is not always made clear. The bank may have a GSA (general security agreement) on the company, or you may have signed personally on the corporate accounts. As a business owner, be sure you understand the relationship you have with your bank. Ask questions!
Please feel free to contact us if you have further questions regarding co-signing or anything else related to financing for your business needs.