Business Loan Personal Guarantees: What You Need to Know
Ezra Cabrera | February 7, 2023
As a business owner, you may be asked to provide a personal guarantee when borrowing money or taking out a lease. A personal guarantee is an agreement that you will be personally responsible for debt repayment if your business cannot.
Understanding the implications of a personal guarantee is important before agreeing to one. This article will explain what you need to know about business personal guarantees, including the risks and potential benefits.
Key Takeaways
A personal guarantee is a legally binding contract holding you responsible for paying the loan in case the business defaults.
There are two types of personal guarantees: limited guarantees and unlimited guarantees. In a limited guarantee, the guarantor is only responsible for repaying a specified percentage of the debt. Unlimited guarantees hold the guarantor fully responsible for the entire debt.
You can get a loan without a personal guarantee, but you’ll likely need other ways to appease the lender – like offering a larger deposit or providing a letter of credit.
What is a Business Loan Personal Guarantee?
A personal guarantee for a business loan is a legally binding contract that holds you responsible for loan repayments in case of the business defaults. It’s a type of security most lenders require when you apply for small business loans, like lines of credit, term loans, or business credit cards.
Your personal assets, such as cars, property, or bank accounts, can be used as a guarantee, meaning lenders can go after your personal assets before they can access your business assets.
Personal guarantees increase your chances of qualifying for a loan because it reduces the lender’s risk. As a result, loan requirements may be more lenient than loans that don’t require a guarantee.
2 Types of Personal Guarantees
There are two types of personal guarantees:
Limited Personal Guarantees
With a limited personal guarantee, the guarantor is only responsible for repaying a specified percentage of the debt in case the business fails to repay. This guarantee is often used when multiple people are involved in the business, and each person can be held responsible for a portion of the debt. For example, the lender can go after each guarantor for 20% of the loan balance.
Unlimited Personal Guarantees
An unlimited personal guarantee holds the individual, usually a business owner or key executive, fully responsible for the entire debt. If the business fails to fulfill its obligations, an unlimited guarantee allows lenders to go after the sole guarantor to recoup the full balance. Lenders will first seize the liquid assets, but if those aren’t enough, they can also repossess other assets like vehicles and real estate.
Factors to Consider Before Signing a Personal Guarantee
Here are a few factors to consider before you sign a personal guarantee contract:
Need for financing
Think about the risks before you sign a personal guarantee for a business loan. Be sure you need a loan to grow your business and that you’re not borrowing more than you need. Do your research before making any big decisions.
Odds of approval
Signing a personal guarantee makes it easier to get a business loan. However, well-qualified businesses with high credit scores, good financials, and a proven track record may qualify for favorable terms without a guarantee. Assess your approval odds based on your lender’s requirements and see if you can get funded without personal guarantees.
Lender requirements
It’s important to understand the lender requirements for guarantors and determine whether you can meet those requirements.
Business’ ability to repay the loan
Evaluate your business’s cash flow and ability to repay the loan on time before applying. Be sure you’re generating enough funds to cover monthly or weekly loan payments.
Your ability to repay the loan
Even if your business is stable enough to cover loan payments, it’s still important to ensure that you can personally cover the loan amount just in case. Consider whether your personal assets are enough to pay off the debt if necessary and if you have the means to replace any assets that might be at risk if you sign a personal guarantee.
Collateral available
If your business has valuable assets (real estate, inventory, or equipment), you may be able to skip a personal guarantee by using these assets as collateral. In this case, it may be better to consider a secured business loan than signing a personal guarantee.
Do All Small Business Loans Require Personal Guarantees?
Not all small business loans require a personal guarantee, but it’s common for most forms of financing, including “unsecured” business loans. The 2020 Federal Reserve survey discovered that only 59% of small businesses used a personal guarantee to secure a loan. Personal guarantee requirements depend on the loan type, business creditworthiness, and lender requirements.
Bank and online lenders require a personal guarantee on some of their products. In contrast, the Small Business Administration (SBA) requires unlimited personal guarantees from borrowers with an equity of 20% or more.
While you can get a loan without a personal guarantee, you’ll likely need other ways to appease prospective lenders. For example, lenders may offer a limited personal guarantee or waive the need entirely if you provide a letter of credit or a larger deposit.
How to Reduce the Risk of Personal Guarantees
If you’ve decided to go for a personal guarantee, it’s important to have a solid plan for paying it back in full and on time. Before you sign on the dotted line, take a close look at the contract.
Here are some best practices to follow to help you make an informed decision:
Be wary about “continuing guarantees”
Continuing guarantees are when the guarantor agrees to remain liable for the debt even if the loan is refinanced or extended. In other words, the obligation to repay the loan continues even if the original loan is replaced with a new one. Lenders often require a continuing guarantee to add an extra layer of security, especially for those with limited credit and business history.
However, you should be wary of this because it can significantly increase your personal financial risk. It can have a lasting impact on your finances and credit and limit your ability to secure future financing from other lenders. Consider the long-term implications before agreeing to a continuing guarantee.
Ask questions about unclear terms or phrases
Keep an eye out for vague terms, and don’t hesitate to ask your lender for clarification on any language that may be open to interpretation. It’s always better to clear up any confusion early on to ensure you and the lender are on the same page.
Watch for the words “joint” and “several”
The words “joint” and “several” in a personal guarantee determine the extent of your personal liability.
A joint personal guarantee means that you and one or more other individuals are collectively responsible for repaying the debt. If your business cannot repay the loan, the lender can come after any joint guarantors to collect the debt.
A several personal guarantee means that each guarantor is only responsible for a portion of the debt rather than the entire loan amount. This can protect the guarantor, as they will only be responsible for paying their share of the debt.
Seek professional advice
Consult with a business attorney or financial advisor to review your options and determine the best strategy for reducing your risk.
Conclusion
Business loan personal guarantees are a big deal, and you want to make sure you’re in the know. The key is understanding what it means to be a personal guarantor and the potential risks before making a final decision.
Remember that a personal guarantee means you’re on the hook for repaying the loan if your business can’t, so it’s important to do your due diligence to help you make the best decision for your business.
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