Every small business requires funding at some point or another. The problem is that funding a startup or financing a business acquisition is often much more difficult than people anticipate. If you don’t have the capital to start a business, you will often try to get business loans. Depending on the loan and lender, however, you may need to sign a personal guarantee to get approved for lending.
What is a personal guarantee?
A personal guarantee is a legally binding agreement that a business owner signs when taking out commercial loans. The agreement states that if the business fails to make its loan repayments, then their personal assets will be seized to pay back the amount. Personal assets might include real estate, vehicles or anything of economic value.
According to the SBA:
“When a loan guaranty is approved, we expect all available company assets to be offered as collateral. If company assets are insufficient to fully secure the loan, liens on personal assets may be required. Often, this means a lien on residential real estate.”
The SBA also states that anyone with a 20% or greater stake in the business should be part of the personal guaranteeing process. This is because lenders want owners and partners to have a financial incentive to grow their business and not be free to walk away from debt. Having personal assets means you’re more likely to be approved for a loan. However, putting your personal stability on the line for the sake of your business does come with risks.
What is an SBA loan?
An SBA loan is funding provided by the Small Business Administration (SBA). The SBA provides a number of different loan programs to help small businesses launch and grow. Although SBA loans require slightly more paperwork than conventional loans, their low interest rates for business loans and longer loan terms make applying worth the effect if you qualify.
The SBA does not administer loans themselves. Instead, they are a government program which guarantees a small portion of business loans on behalf of the borrower. It means that if you can’t pay back your loan for whatever reason, the SBA will be responsible for their guaranteed share of the total amount – usually around 50 – 85%.
The appeal of the SBA is that it minimizes risk for the lender and proposes attractive terms for the borrower. However, in order to get approved for an SBA loan, you will need to prove your creditworthiness and have experience in your field. If your lender thinks there is a risk to lending to your business, they may require a personal guarantee for the loan.
Do I need a personal guarantee for an SBA loan?
Whether or not you need a personal guarantee for SBA commercial loans depends on the type of loan you’re applying for, as well as the lender. This is because to qualify for an SBA loan; you will typically need to fit the bank’s lending criteria in addition to meeting SBA guidelines.
How much will I need to pledge for an SBA loan?
The amount you are required to pledge as a stakeholder will depend on the loan amount, how much the SBA guarantees, and how many stakeholders are signing the guarantee. This is because there are several different types of personal loan agreements, each with their own terms:
Unlimited personal guarantees: If you sign an unlimited guarantee, you agree that the lender can recover 100% of the loan (not guaranteed by the SBA), as well as any legal fees your loan incurs. They can do this in any way they see fit. This guarantee offers you no financial protection is your business isn’t successful, so it’s important that you know what you are signing.
Limited personal guarantees: With a limited personal guarantee, you set an agreed collateral value on what can be recovered from your personal assets. This offers you more protection than an unlimited guarantee in the event that you fail to repay your loan on time. However, you still need to be careful when signing this agreement.
Several guarantees: This agreement involves each party offering a percentage of liability for the loan. This is only an option if there are multiple stakeholders for your business. Each person with a stake in your business will need to pledge a maximum amount they are liable for if the business defaults. This is typically a fixed percentage of your total loan amount. Once the agreement is signed, this amount cannot be altered.
Joint and several guarantees: This agreement differs from several guarantees in that each stakeholder is liable for the entire guaranteed amount in the event that others cannot pay their portion. Signing a “joint and several” guarantee means that if your business defaults and your partners don’t have enough personal assets to cover their percentage of the loan, then your lender can recover their unpaid amounts from your personal assets. You should be particularly careful when signing one of these agreements, particularly if you have joined up with new partners.
When applying for equipment financing and acquisition loans from the SBA, you may be required to sign a personal guarantee. It covers the amount not backed by the SBA in the event that you default on your loan repayments. While the interest rates for business loans from the SBA are low and the repayment terms are long, there are still certain criteria that you need to meet in order to qualify for a loan.
Whether or not you need to pledge a personal guarantee depends almost entirely on the lender. However, most lenders will require some form of guarantee to protect their portion of the loan. One way to minimize the risks is to sign a “joint” or “separate” guarantee so that you are not the only stakeholder who is liable for the loan.
Whichever personal guarantee you sign, you must always read the terms carefully and discuss them with your lawyer or financial advisor if you’re unsure of the terms.