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Don't personally guarantee your startup

One of the newsletters I subscribe to ran a sponsored post for Paintbrush, a firm that gives idea-stage founders a $50,000 loan to prove out their idea. The pitch on the front page is, “No rich aunt or uncle? No worries.”

My initial reaction was positive: I do think access to capital for founders from non-wealthy backgrounds is important. We’re missing out on so many important businesses by perpetuating an ecosystem that works best for people with deep pockets (who, in turn, tend to come from a narrow set of demographics). But the more I dug in, the more I think this is a bad deal, and I wanted to talk about why.

Based on their literature, Paintbrush provides a $50,000 loan with a very low-friction application and a fast decision. But the total repayment amount can be as much as $75,000, tied to a personal founder guarantee. That means that if your startup doesn’t work, you as a founder are required to pay that amount back at an amount pegged at 15% of your pre-tax income. For example, if your total income was $150,000, you would pay back $22,500 a year. That amounts to around 22% of what your post-tax takehome pay would be before payments like health insurance and rent.

Investor and founder Erik Severinghaus, in a piece entitled Never, Ever Personally Guarantee Your Startup:

Remember that 75 percent of even venture backed startups fail. Behind every one of those failures is a story of heartbroken entrepreneurs trying valiantly to extricate themselves from a challenging situation while retaining some modicum of dignity. Putting the money aside, that emotional hell is one that you don't want to live through, and it's exponentially worse if your creditors can come after your personal assets in addition to the corporate ones.

Not only that, but if you want to follow the VC path — or, for example, take part in an accelerator — you should know that investors take a close look at debt that you might have on the books. At an earlier stage startup, debt is a higher percentage of a startup’s total value, so early investors may take a particularly unkind view of it.

I expect that the founders of Paintbrush are trying to do the right thing. And in some cases, it may well still be a good solution! But I’d warn entrepreneurs to think about it very carefully before plunging in. Even if they provide a quick answer about your “funding”, you need to take your time and consider your options — and particularly the consequences if, like 90% of startups, yours fails. A fast process can lead to emotional decision-making where you’re all signed up before you consider the consequences. There may be better routes forward.

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