Co-signing a loan

[Sojourner]

Kind of a long-winded story, so here's the TL; DR for those who just want the gist of it: Under what circumstances would you consider co-signing a loan for a small, local business run by a few people you recently met (and like), who seem smart, driven, and pretty savvy, but where the business itself is somewhat marginal from a financial standpoint?

Several days ago, I was asked by a few people whom I've recently come to know and like if I'd be interested in working with them on a part-time basis to improve their IT infrastructure and handle other technology-related aspects of their small startup business (a wholesale distribution company). During the same conversation, they asked if I might consider co-signing a loan for $35,000 to help them grow and operate the business. They mentioned that they'd be willing to give up some equity in the company in return for my services, i.e., for doing the IT work and co-signing the loan.

After listening very carefully to their pitch and asking a bunch of questions about the business and their finances, I told them I'd certainly be willing to do some part-time IT work for them. The kind of stuff they need would be pretty easy for me to accomplish and might be kind of fun, actually. And I'd love to help these guys succeed, since they seem like great people and we get along really well.

As for the loan, though, my initial reaction was a combination of surprise, confusion, and reluctance. I understood that they were offering a percentage of equity in the business, but I was having trouble making sense of the risk/reward calculation. Given that it's a small start-up company with only 3 employees and they don't have a solid, reliable, growing base of suppliers and retailers (they are working to build these up, obviously), I feel like there are pretty substantial risks involved in co-signing a sizable loan. An obvious example would be, what if one or more of the 3 people (all of whom are vital to the business) were to leave or get hit by a bus or somehow drop out of the picture? This would almost certainly result in a major decline in revenue, leading to a possible default on the loan, and then I could be left holding the bag.

So, I'm struggling to figure out why I would co-sign such a loan. Let's say they gave me 5% of the business in return for the loan assistance and being their IT consultant. If they were a promising little high-tech or Internet startup, I would say "Well, 5% might be worth a boatload in 3 or 4 years if they end up getting acquired." But in this case–with a small, brick-and-mortar, importer/distributor company–I don't see that sort of potential payoff. Maybe it ends up generating some trickle of cash down the line if the company's profits grow substantially, but for me, that's a fairly marginal reward in return for the nontrivial risk I'd be taking on as co-signer of a large loan.

I'd appreciate any thoughts, suggestions, feedback or words of wisdom on this situation. I'd especially be interested to know under what circumstances, specifically, you'd be willing to co-sign such a loan. Are there specific criteria you'd apply, such that only once all those criteria were met, you'd go ahead with it?

[pb4uski]

I think you are right to be wary. If the lender is insisting on a co-signer then they, who probably have more information on the business than you do, are equally wary.

I hope that I never end up in the position of being asked. Perhaps they know that you are a high roller.

[Brat]

In investor would NEVER co-sign a loan. If they need capital they need to bring in an investor.

You could offer to defer compensation for the work you do for the start-up. Write up an agreement to that effect if you want to support the firm. In that way your financial risk is limited to lost compensation.

[JoeWras]

Quote:

Originally Posted by Brat In investor would NEVER co-sign a loan. If they need capital they need to bring in an investor. You could offer to defer compensation for the work you do for the start-up. Write up an agreement to that effect if you want to support the firm. In that way your financial risk is limited to lost compensation.

Yes. I have a friend doing exactly this. IT also.

[SheitlQueen]

I would never co-sign a loan. If the bank won't fund them, there's a reason.
If it won't take a chance on them, why should you?

I agree with Brat, defer compensation for the work you do rather than co-sign a loan.

[splitwdw]

These are people that you just met. Why would you co-sign a loan? I'm curious how they know that you are good to co-sign a loan? Do the IT work if you feel like it but don't get talked into financing the company. Do not make a financial decision because you "like them".

[ExFlyBoy5]

Quote:

Originally Posted by Brat In investor would NEVER co-sign a loan. If they need capital they need to bring in an investor.

This x1000. If you are looking for way to invest some "play money", there are lots of vehicles out there that will let you get in the "ground floor".

You mentioned that you "just met them"...this is a very, Very, VERY large RED LIGHT in my opinion. Do these guys (gals) not know ANYONE else or did you give them the idea that you "might" be interested in investing? I ask that because I have a good friend (have known since 1983'ish) that has a fairly successful business, but I also know that he's not so great w/ money. He recently asked if I would "invest" in some commercial space with him...and it was very awkward. I would help the guy bury a body, but I can't bring myself to invest in his company and NO WAY would I co-sign a loan with him.

[pj.mask]

Firm NO - you don't have the money to cover the loan (unless you do and want to risk it). Most good companies I have seen fund their [spell check] growth through sales or partnership with a big corp who really needs their services. Big corps often provide capital for an in need service agreement.

But if you are interested in investing let me tell you about this great opportunity! I'm starting a IT company as well, you just need to invest $5k for new computers and TV at my house ... I'm sure we will generate income off of it! Just send a check!! (As others mention, new 'friends' - very likable and quickly ask for $$ sounds like a reception for disaster)

[imoldernu]

Quote:

Originally Posted by Sojourner I'd appreciate any thoughts, suggestions, feedback or words of wisdom on this situation. I'd especially be interested to know under what circumstances, specifically, you'd be willing to co-sign such a loan. Are there specific criteria you'd apply, such that only once all those criteria were met, you'd go ahead with it?

No advice, but I think you've answered your own question.

[OldShooter]

Quote:

Originally Posted by Sojourner ... people whom I've recently come to know ...

Scam probability = high.

If you haven't abandoned this bad idea yet, ask your attorney to run background checks (liens, judgments, arrests & convictions, etc.) and credit checks on the company, the principals, and any companies that the principals have previously been associated with. That information could be very revealing.

[jazz4cash]

Have you seen their financials? 35k is a rather small amount that they could put on a credit card ( or a few cards) if that's all the financial support they need.

[Sojourner]

Quote:

Originally Posted by pb4uski Perhaps they know that you are a high roller.

Hmmm... I don't think I've ever given them a reason to believe this. I certainly have never come right out said something like "Oh, by the way, I have an excellent credit score and I'm quite wealthy." I have mentioned, though, that I do part-time IT consulting work and that I'm semi-retired.

Quote:

Originally Posted by SheitlQueen I would never co-sign a loan. If the bank won't fund them, there's a reason. If it won't take a chance on them, why should you?

Yes, this is one of my primary concerns. And from what I've read about co-signing loans, in the case of a default, the creditor usually comes after the co-signer(s) first, because the principle borrower is considered to be far less likely to be able to repay the debt. After all, they needed a co-signer to get the loan in the first place!

Quote:

Originally Posted by ExFlyBoy5 You mentioned that you "just met them"...this is a very, Very, VERY large RED LIGHT in my opinion. Do these guys (gals) not know ANYONE else or did you give them the idea that you "might" be interested in investing?

I first met them about a year ago, but we've only become "friends" (i.e., I've only gotten to know them well) over the past 3-4 months. We've had some in-depth conversations about common interests, about what led them to start their business, and all sorts of things like that. But I don't recall ever saying anything that would give the impression that I have an interest in (or have the means to) invest in their business. I'm sure they've surmised that I'm pretty secure financially, just based on casual observation and conversation, but it struck me as quite a leap to go from that to "Hey, would you be willing to co-sign a large loan for us?"

Quote:

Originally Posted by OldShooter Scam probability = high. If you haven't abandoned this bad idea yet, ask your attorney to run background checks (liens, judgments, arrests & convictions, etc.) and credit checks on the company, the principals, and any companies that the principals have previously been associated with. That information could be very revealing.

I've spent enough time around these people and around their business over the past year to know that it's not an outright scam. They are working long hours every day (including weekends) trying to build the business and have a sizable amount of inventory in their warehouse. Their problem seems to be not having enough of a sales force to go out and sign up retailers to carry their products. However, I take your point about background checks and credit checks. I have a feeling that these might turn up some negative stuff, based on some of the stories I've heard regarding the pre-history of this company.

Thanks to all for the comments and feedback. I'm not going to co-sign the loan, but I will go ahead with the IT consulting work. Even if I never get paid for it, it'll be some interesting and enjoyable work (I hope). And as I mentioned previously, I do really like these people and would like to help them succeed in some way.

[Walt34]

Quote:

Originally Posted by pb4uski I think you are right to be wary. If the lender is insisting on a co-signer then they, who probably have more information on the business than you do, are equally wary.

What he said.

Despite their reputations for evilness, banks are businesses and the ones that are still in business are at least reasonably good at the things they do, one of which is assessing risk.

If the professional moneylenders want a co-signer there is almost certainly a very good reason for that. As Brat suggested if you can afford to write off deferring compensation in exchange for a part of the business, do that, but I'd never co-sign a loan, especially for someone I'd just recently met and running a financially marginal business.

[Texas Proud]

The big question in my mind is what you think the company is worth?

IOW, if it is a small company and worth maybe $100K, then I would want at least 1/3rd of the company....


Remember, 5% of nothing is still nothing...

I would also be VERY careful that what you sign has NO cross collateral language in it... when my BIL was borrowing lots of money back in the 80s he found out that one of the guarantees he had signed opened him up to every loan the bank made to the company (it was his company, so not as bad) going forward.... and as long as the company owed money he was on the hook... if this is the case your liability could grow to a level you could not handle...

[Brat]

OK, point them to incubators and seed VCs. Here is a list:

https://www.inc.com/sunil-rajaraman/...on-valley.html

Y Combinator, Mountain View, CA is very well respected in the Silicon Valley.

Here is a list of others across the country:

Tech Stars, Boston MA, Boulder CO, NYC, Seattle WA, Microsoft (Seattle WA) + the Cloud Accelerator in San Antonio, TX
Excelerate Labs, Chicago, IL
500 Startups, Mountain View, CA
Capital Factory, Austin TX
DreamIt Ventures, Philadelphia, PA + programs in Austin TX & NYC
Entrepreneurs Roundtable, NC
I/O Ventures, San Francisco, CA
Tech Wildcatters, Dallas, TX
Angel Pad, San Francisco, CA

Disclosure here: my DD is the CFO of a VC.

They will need to give up some % interest in the business BUT they will also receive the guidance of experienced entrepreneurs and connections.

[JustCurious]

Quote:

Originally Posted by Sojourner Under what circumstances would you consider co-signing a loan for a small, local business run by a few people you recently met (and like), who seem smart, driven, and pretty savvy, but where the business itself is somewhat marginal from a financial standpoint?

I can't think of any.

[joeea]

Quote:

Originally Posted by Sojourner they asked if I might consider co-signing a loan for $35,000 to help them grow and operate the business.

There's no way I'd ever co-sign a loan for someone I'd just met.

If I learned enough about the company, really like what I saw, and I already had my lawyer on retainer, I might be willing to loan them $35,000 myself in exchange for a reasonable rate and payment schedule, plus some equity. Probably not though.

[Sojourner]

Quote:

Originally Posted by joeea If I learned enough about the company, really like what I saw, and I already had my lawyer on retainer, I might be willing to loan them $35,000 myself in exchange for a reasonable rate and payment schedule, plus some equity. Probably not though.

My feelings exactly. In fact, this is what I would have expected to be asked, as opposed to being asked about co-signing a loan. Even if I were able to structure a term loan with, say, 15% APR, I'd still feel like the risk/reward balance was off. Making an extra $5,000/year pre-tax for a few years wouldn't change my life in any significant way, but losing $35K would be painful and extremely annoying.

[flintnational]

As you know, cosigning means you are on the hook for the loan. So another way to look at this is, "would you invest $35k of your own money". That is about what you are doing. And, that might be the preferred arrangement. But then you would be a venture capital investor. Do you have any skills in this area? I don't and therefore I would avoid this situation.

FN

[kgtest]

I've been offered to co-sign before, and it's basically like asking if you are willing to give someone money. My answer was, no...followed by "why did the lender require a co-signer"

Then I usually recommend the bank I do business with, and that turns into "well see we filed for bankruptcy ..."

no, YOU filed for bankruptcy, YOUR credit is not worthy of a lender and YOU should have a great day, as I am going to go back to fixing IT stuff for a paycheck.

You have to wonder, if they are asking their IT guy for a loan, who else have they asked?