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I am a co-founder in a small business that has a number of investors. We are looking at doing an expansion that includes an capital raise and a SBA loan. The loan is roughly 5 times larger than the capital raise.

Myself and the two other co-founders intend to co-sign for the loan but we plan to raise the capital externally since it is more than our current investors can re-invest.

To do this we plan to create a new share class and need to figure out how to split these shares between ourselves (for guaranteeing the loan) and the new investors.

Is there a standard way of valuing the act of guaranteeing the loan? Obviously it is not 1:1 with the capital raise, but maybe some ratio of the loan amount?

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    What do you mean by "valuing the act of guaranteeing the loan"? No money changes hands with a guarantee so I'm not certain what your end goal is.
    – D Stanley
    Feb 10, 2017 at 17:02
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    My end goal is to split new equity in the company in a fair way. Obviously whomever puts in cash should get something, but presumably anyone that takes on the loan guarantee should also get something in exchange for their risk exposure. Maybe it's 5% or 10% or some percent of the total loan amount. Or maybe there is a different way of calculating the value there.
    – funkyeah
    Feb 10, 2017 at 19:44
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    To give an example. Let's say we are raising 1.2 Million dollars. 1 Million of that will come from a loan, and 200k will come from capital raise. We are going to distribute 1 million shares in equity as part of this raise. What percent should go to the capital investors and what percent should go to the guarantors of the loan?
    – funkyeah
    Feb 10, 2017 at 19:48
  • to be honest, this does not sound normal. If I were an investor in your company I'd be hard pressed to accept this as an acceptable action.
    – NotMe
    Feb 17, 2017 at 15:25
  • @NotMe It is extremely common for a startup business to have a loan from the bank guaranteed by the principle investor(s). This is because the bank does not like the risk associated with an unproven business. If they were to loan you the money anyway, the interest rate would need to be abnormally high to cover the risk [although they likely wouldn't loan it at all]. What is slightly more odd (but still relatively common) here is that there are multiple investors and not all are guaranteeing the loan.
    – Grade 'Eh' Bacon
    Feb 21, 2017 at 14:46

4 Answers 4

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The guarantee's value to you is whatever you have to pay to get the guarantee, assuming that you don't decide it's too expensive and look for another guarantor or another solution entirely. How much are you willing to pay for this loan, not counting interest and closing costs? That's what it's worth.

See past answers about the risks of co-signing for a realistic view of how much risk your guarantor would be accepting and why they should hold out for a very substantial reimbursement for this service.

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  • So value the guarantee as if I wasn't guaranteeing it myself? E.g. If I paid money upfront for someone else to take on the guarantee risk? Do you know of a service that would do this?
    – funkyeah
    Feb 11, 2017 at 19:41
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    Sorry, missed the point that you were asking about being the guarantor of your own company. In that case the guarantee is worth what you are able to commit to paying times the odds of your paying it. The latter is a matter of opinion, so I'm not sure you can say what this might be worth to other investors.
    – keshlam
    Feb 12, 2017 at 5:59
  • I'll accept this answer if I can't get a more concrete answer. It doesn't seem like your suggested process would work for even my simplified example.... as a guarantor or co-signor you commit to 100% of the loan amount, as you add more co-signors in theory you are exposed a fraction of that. The odds of me paying it should we default doesn't seem like it should matter... the investors will be out their capital but they are still not on the hook for the loan repayment, only I and any other co-signors would be.
    – funkyeah
    Feb 16, 2017 at 17:39
  • Or are you saying the "odd of your paying it" in the sense of the chance that the business would default on the loan? Of course this is something that is difficult to say. It roughly doubles the equity in the company so the expansion is very significant and with that comes real risk, but being part of the thing makes it more difficult to adequately judge the risk. Again, would some external service be applicable in gauging the risk?
    – funkyeah
    Feb 16, 2017 at 18:09
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    @funkyeah It appears that you may be downplaying the risk that you actually need to cover the loss of the loan yourself, should the business be unable to pay it. Remember - if you can't provide an amount that the business should compensate you for guaranteeing the loan, it implies that you are giving the company an unquantified benefit. I doubt you could find an external service that would value the guarantee - you are basically asking for the cost of insurance against your business failing. Guarantee services may exist, but likely not for small startups - assessing your risk is expensive.
    – Grade 'Eh' Bacon
    Feb 21, 2017 at 14:50
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The standard goal of valuing anything is to seek the fair price for that thing in the open market. Depending on what is being valued, that may or may not be an easy task. eg: to value your home, get a real estate appraiser, who will look at recent market sales in your area, and adjust for nuances of your property. To value your loan guarantee, you would need to figure out what it is actually worth to the business, which may be difficult.

In a perfect world, you would be able to ask the bank to tell you the interest rate you would have to pay, if the loan was not guaranteed. This would show you the value you are providing to the business by guaranteeing it. ie: if the interest would be $100k a year unguaranteed, but is only $40k a year guaranteed, you are saving the business $60k a year. If the loan is to last 5 years, that's a total of $300k. Of course, it is likely the bank simply won't offer you an unguaranteed loan at all. This makes the value quite difficult to determine, and highlights the underlying transaction you are considering:

You are taking on personal risk of loan default, to profit the business. If you truly can't find an equitable way to value the guarantee, consider whether you understand the true risk of what you are doing.

If you are able to determine an appropriate value for the loan, consider whether increasing your equity is fair compensation. There are other methods of compensation available, such as having the company pay you directly, or decrease the amount of capital you need to invest for this new set of equity.

In the end, what is fair is what the other shareholders agree to. If you go to the shareholders with anything less than professional 3rd party advice (and stackexchange does not count as professional), then they may be wary of accepting your 'fee', no matter how reasonable.

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You are confining the way you and the other co-founders are paid for guaranteeing the loan to capital shares. Trying to determine payments by equity distribution is hard. It is a practice that many small companies particularly the ones in their initial stage fall into. I always advise against trying to make payments with equity, weather it is for unpaid salary or for guaranteeing a loan such as your case.

Instead of thinking about a super sophisticated algorithm to distribute the new shares between the cofounders and the new investors, given a set of constraints, which will most probably fail to make the satisfactory split, you should simply view the co-founders as debt lenders for the company and the shareholders as a capital contributor.

If the co-founders are treated as debt lenders, it will be much easier to determine the risk compensation for guaranteeing the loan because it is now assessed in monetary units and this compensation is equal to the risk premium you see fit "taking into consideration the probability of default ". On the other hand, capital contributors will gain capital shares as a percentage of the total value of the company after adding SBA loan.

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You should ask the bank supplying the SBA loan about the % of ownership that is required to personally guarantee the loan. Different banks give different figures, but I believe the last time I heard about this it was 20% or more owners must personally guarantee the loan.

Before you spend a lot of money on legal fees drawing up a complicated scheme of shares, ask the bank what they require. Make sure you speak with an underwriter since many service people don't know the rules.

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