How to compensate personal guarantor in a syndication transaction

Question

Would like to learn how a personal guarantor is compensated for taking the risk. Sponsor just purchased a land to build an apartment. Sponsor is in the process of set up an LLC with multiple members put in equity money and LLC to borrow a loan. Lender of course requires a personal guarantor. One shareholder of Sponsor and who also takes about 30% membership interest in LLC will be the personal guarantor. Does he usually receive compensation for his taking this risk to be the personal guarantor - such as, he gets more equity interest than the percentage of his investment, or a percentage of distribution being carved out to this person?

Logan McKay Zylstra · Answer

Yes. He would definitely get an equity bump and possible return pref in addition.

Dan Rowley · Answer

@William Yeh   Under non-recourse loans, the guarantor is not generally responsible for losses the lender incurs, unless they commit certain bad acts; such as fraud, waste, damage or destruction, misapplication, misrepresentation, bankruptcy, or environmental contamination.  So there is still someone that needs to sign their name and would be responsible in the even to of 'bad actor' behaviors.

Ronald Rohde · Answer

Yup, common bad boy carveouts...

Benjamin Aaker · Answer

A loan guarantee fee is the cleanest. Have the guarantor come in as an investor for the same terms as the rest. As the guarantor, he/she gets a fee whether up front or annually. Keep in mind you may need multiple guarantors so this can get expensive. Also, sophisticated investors will want to know who is giving the guarantee. They avoid deals where someone with almost no involvement in the deal comes in as guarantor. It might mean that the Principal has poor financials.

Lane Kawaoka · Answer

For non-recourse debt - 0-5% of the equity is the ball park.

For recourse debt - 1-10%.

I personally would not KP/loan guarantor anyone who does not have 2-5M in personal net worth but that is just me. Typically operators who have a good track record don't need additional KPs which is the ironic thing too. Good luck and make sure you have collateral not in equity (which is worth nothing if things go wrong).

William Yeh · Answer

@Dan Rowley I'm confused by your post. If it's non-recourse, then by definition there are no guarantors on the loan and the loan is guaranteed by the underlying collateral alone no? Recourse debt requires a guarantor.

Ronald Rohde · Answer

Yes, lots of structures, Fee based, % based, or equity carry.

it all depends on the risk, the leverage, and the value add to your project. There's good videos on YouTube about Key principal for Fannie

Connie Dai · Answer

Logan, thank you.

Dan, Appreciated. The 5%, 10% in your last sentence refers to the 5% or 10% of "equity"?

Dan Rowley · Answer

@Connie Dai   There are some rules of thumb but that need to be tailored to the specific situation.  You can probably also google and find good online resources on the topic.

The two main ways to compensate a loan guarantor is 1) an annual fee and/or 2) a percentage of equity.>Annual Fee – If it is a nonrecourse loan, the typical fee is 0.25% paid out annually. If the loan balance at the end of year one is $10 million, for example, the fee would be$25,000.>Equity – In addition to an annual fee, you can offer an equity stake in the deal.Depending on how you negotiate, what the projected returns are for the deal, andhow many other options you have to guarantee the loan, for a nonrecourse loan, the percentage can be 5%, 10%, or more.

How to compensate personal guarantor in a syndication transaction

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