Startups often leverage business credit cards to cover expenses. Many of these credit cards require personal guarantees, meaning that the card holder (who is typically the founder) has to cover the balance if the company is unable to.
This generally isn’t a problem - until it suddenly is. If the company shuts down and doesn’t have enough cash to pay the credit card debt, a founder may become personally liable for paying off the card balance.
Even where the company has some cash upon dissolving, it’s rarely as simple as applying all remaining cash toward the credit card debt.
In this article, we explain personal guarantees and what to do if the company is insolvent and shutting down.
Article Contents
What is a personal guarantee?
A personal guarantee means that the card holder must cover the debt if the company is unable to pay it – they are guaranteeing the obligation of the company to repay the credit.
Many credit card issuers require personal guarantees for business credit cards. The personal guarantee provides the issuer extra confidence that a business owner won’t simply use a credit card for personal benefit and leave the company with the debt.
For early-stage startups, the founder is typically the individual that personally guarantees the business credit card.
Some business credit cards do not require personal guarantees – but credit card issuers typically only approve these for companies that meet fairly high revenue and cash-on-hand requirements. Options include:
There can be consequences to both the business and the personal guarantor if business credit card debt is not paid off on time:
Higher interest rates and steep late fees
Increased risk of the company’s inability to pay the growing balance
Damage to the company’s credit score
Damage to the guarantor’s personal credit score
Importantly, personal guarantees supersede limited liability protection that is usually afforded for individuals against company debt.
How do I know if a business card has a personal guarantee?
The credit card’s terms and conditions outline if there is a personal guarantee. Look for key terms such as “personal guarantee” or “joint and several liability” to identify the relevant section.
Shutting down a company with a personally guaranteed business credit card
Importantly, credit card debt generally gets treated as any other creditor in the priority order of creditors – even when it is subject to a personal guarantee.
What is the priority order of creditors?
Delaware law requires that creditors are paid in the following order:
Secured creditors
Unsecured creditors
Preferential
Non-preferential
Equity holders
Credit card debt typically falls under the category of non-preferential unsecured creditors.
Other common non-preferential unsecured creditors typically treated in the same class as credit card debt include:
Noteholders
Vendors / service providers
Unsecured business loans (such as PPP loans)
Thus, when distributing remaining company assets to creditors, credit card debt is normally required to be repaid pro rata alongside other non-preferential unsecured creditors.
In the example distribution waterfall (spreadsheet) above, the company has available cash greater than the amount of credit card debt, but due to the priority order of creditors and amounts owed, is not able to fully repay the card's debt.
My company is shutting down and has some cash, but not enough to pay all outstanding liabilities. Can the company pay off the credit card debt first?
Generally not – unless the company has enough assets to fully repay all secured and unsecured creditors.
Particularly as a company approaches or enters insolvency, founders should take caution to not preferentially treat credit card debt by repaying it ahead of other creditors in the priority stack. This type of preferential treatment can become subject to the “fraudulent transfer” rules under Delaware law (6 Del. C. § 13).
Example scenarios of preferentially treating the credit card debt may look like:
Repaying the card balance in an amount outside of the ordinary course of business. For example, the company contributed ~$2k to the credit card balance monthly for the past year, but suddenly contributed $20k a few months before shutting down.
Providing the credit card’s personal guarantor (likely, the founder) a lump sum payment or salary increase without a reasonable business justification a few months before shutting down.
Other creditors may point to fact patterns like the examples above to substantiate claims to distribution proceeds.
My company is shutting down but doesn’t have enough cash to pay the credit card debt. What now?
Below are actions founders can take to manage the credit card situation:
As soon as possible after determining the company will shut down and cannot repay the credit card balance, call the credit card issuer to ask about financial relief programs.
Some card holders may qualify for financial relief programs, which often offer lower interest rates and longer windows to pay off the debt.
Note that enrollment in some financial relief programs may negatively impact the card holder’s personal credit score.
Founders may wish to transfer the card’s balance to a balance transfer business card. Balance transfer business cards with 0% APR can help save money on interest, thus allowing the debt to be repaid faster.
The card holder may be able to make a personal tax deduction for personally contributing to the outstanding balance in satisfaction of the card holder’s personal guarantee. Connect with your personal tax advisor to discuss the viability of this option.
As a broad generalization, for insolvent companies preparing for dissolution, it can be beneficial to pause company payments to creditors (including credit card issuers) until the full list of creditors and outstanding claims is understood. Pausing payments helps ensure that no creditors are accidentally paid preferentially ahead of others.
If the amount of credit card debt guaranteed is substantial, it can be worth contacting other creditors (particularly early convertible note investors) to work out a voluntary plan where other creditors agree to the repayment of additional credit card debt in exchange for, for example, the founder’s continued time and energy winding up the company. The details and advisability of such arrangements are highly fact-specific and do not always make sense.