Taking it personal

Among the various benefits that a company form of business provides, the best one unarguably is the feature of limited liability which essentially means that the shareholders' liability is restricted to the unpaid value of shares. This feature of limited liability also restricts' the lenders rights as they cannot directly hold the shareholders' responsible if their loans are not fully recoverable from the assets of the business. The landscape of doing business and risk taking has changed tremendously because of this feature.

To avoid the risk of non-recovery or partial recovery lenders are now seeking personal guarantees from the promoters. This means that the promoters would now become personally liable if their company isn't able to service its debts.

Taking a personal guarantee from  promoters almost defeats the very purpose of a corporate status. Risk aversion is acceptable but is holding one man or a few men accountable for an organisation reasonable?

Some lenders require the shares of promoters to be pledged for obtaining loans. This scenario is more absurd. The Companies act ranks lenders superior to shareholders. so even if a company fails badly and its assets are sold off the proceeds must first be used to clear debts. Why then do lenders demand shares to be pledged? Further if share prices drop the lenders have a right to demand additional collateral (shares) forcing promoters to put more of their holdings at stake. Adding personal touch to corporate debts only makes promoters jittery.

For instance, the grand future empire which was once dominating the retail segment is now reeling because its promoter Kishore Biyani took excessive debts by pledging his shares. Few initial failures forced him to pledge additional shares. Currently almost his entire stake in the group is pledged. The former retail giant has now succumbed to reality and is in talks with Reliance which is expected to decide the future of Future.

Another famous promoter who failed miserably trying to take on excessive debt is VG Sidhartha(of CDEL). VGS gave both personal guarantees and pledged his shares. The result ....

The corporate status  largely benefits owners as their risk is limited to the amount of funds invested. The status is important to owners as it helps them operate without much burden at the back of their heads. Every major business decision will be affected by the promoter's bias when he assumes personal responsibility for the affair of his company. Breaching the status by means of personal guarantees and pledging of shares brings owners back to square one where they have the risk of losing their personal assets. Thus, lenders demanding personal guarantees in the name of risk neutralization only hampers growth of businesses.