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Business Loans and Personal Guarantees – What You Need to Know
Whether you’re just getting your business off the ground, are launching a new product, or need capital to expand your operations and take things to the next level, at some point, most companies look to take out a business loan. And if you’re exploring business loans, chances are that some (or all) of them require a personal guarantee.
Personal guarantees are the standard for a variety of business loans. But what, exactly, is a personal guarantee? What are the pros and cons? And is signing a personal guarantee the right fit for you and your small business?
What is a personal guarantee?
A personal guarantee is a part of a loan agreement that makes the business owner (and any additional co-signers) personally responsible for the total sum of the loan in the event that the business entity can’t or does not repay that business debt.
Essentially, personal guarantees allow lenders to target your personal assets if your business is unable to repay the loan. A personal guarantee acts as a contract that gives lenders a level of assurance that even if your business struggles financially (or goes out of business completely), they’re still able to collect on their debt by going after your personal assets.
Why do lenders ask for a personal guarantee?
Lending to a small business can be risky—especially if it’s a new business without an established credit history or track record of success. Personal guarantees help mitigate that risk for lenders; with personal guarantees, lenders are more comfortable lending to small businesses, knowing that they have a way to collect on the debt—even if the corporate entity isn’t able to repay the business debt.
In a nutshell, personal guarantees make it more attractive for lenders to loan capital to small businesses—which is why so many loans, including many Small Business Administration loans (also known as SBA loans), require them.
What are the different types of personal guarantees?
There are a few different types of personal guarantees—each of which carries a different level of risk for the business owner.
The first is an unlimited personal guarantee. In terms of risk, an unlimited personal guarantee is the least risky option for the lender and the most risky option for the business owner. With an unlimited personal guarantee, you’re responsible for the entirety of the loan. If your business defaults on payments or can’t repay the total balance, the lender can come after you and take ownership of personal assets (for example, your car, home, or additional real estate assets) to recoup their investment and cover the remaining balance.
The less risky option for borrowers is a limited guarantee. As the name suggests, this type of personal guarantee limits your liability—and limits the amount you would owe the lender in the event your business was unable to repay the loan. With a limited guarantee, you and the lender set an agreed collateral value on what can be collected from your personal assets in the event your business can’t repay the loan.
If you have business partners, there are a few additional personal guarantee options: namely several guarantees and joint and several guarantees.
With several guarantees, each stakeholder in your business is responsible for a percentage of liability for the business loan. So, for example, if you have four stakeholders in your business, each stakeholder could be responsible for paying back 25% of the loan if your business defaulted on payments.
With joint and several guarantees, every stakeholder is responsible for paying back the entirety of the loan if the other stakeholders are unable to repay their share. So, if you sign a joint and several guarantee with your business owners—but when the time comes to pay, they don’t have the personal assets to cover their financial responsibility? You would be on the hook of covering their portion from your personal assets.
Joint and several guarantees are significantly riskier than several guarantees; if your partners can’t cover their share of the business debt, you would be responsible for paying back 100% of the loan.
What are the benefits and risks of signing a guarantee?
Before deciding whether signing a personal guarantee is the right move for you and your business, it’s important to understand the benefits and risks.
Benefits of signing a guarantee
There are a number of potential upsides to signing a personal guarantee, including:
- Signing a personal guarantee can make it easier to access capital. Getting the capital you need can be challenging if you’re a new business, don’t have an established credit history, or don’t have much in the way of business assets. Signing a personal guarantee makes you a more attractive borrower to lenders—and can make it easier to access the capital you need to accomplish your business goals.
- Being willing to sign a guarantee will make more business loan options available. While there are business loans out there that don’t require a personal guarantee, a huge portion of business loans do. By being willing to sign a personal guarantee, you’ll have a significantly higher variety of loan options available to your business.
- Signing a guarantee can help you secure better loan terms. Because personal guarantees mitigate risk for lenders, they’re often willing to offer better loan terms, including lower interest rates.
- Personal guarantees don’t require a specific asset or collateral. Certain loans require you to put up a specific asset or collateral in order to secure the loan. Personal guarantees, however, offer more flexibility; you have to repay the debt if your business defaults, but not through any specific asset—so there’s no need to worry if you don’t have any specific type of asset (like a home) to use as collateral.
Clearly, there are a variety of benefits to signing a guarantee. But there are also a number of risks. Some of the risks associated with signing a personal guarantee for your business loan may include:
- Your personal assets are at risk…When you sign a personal guarantee, you’re putting your personal assets on the line. If your business is unable to repay that debt, all of your personal assets—for example, your home or your car—could be seized by your lender.
- …and so is your credit score. Personal guarantees also tie your personal finances to your business finances. If your business defaults on the loan, it could have an impact on your personal credit, which could make it harder to obtain a personal credit card, line of credit, mortgage, or loan in the future.
- Your spouse’s assets may also be at risk. Some personal guarantees also require spousal signature—so if you’re unable to pay your business loan, any personal assets under your spouse’s name could also be seized to repay the debt.
Do your research before deciding whether a guarantee is the right move for your business
When it comes to whether you should sign a personal guarantee for your business, there’s no right or wrong answer; it’s going to depend on you, your business, and the terms of your business loan.
Before you decide whether a business loan is the right fit for your business—and whether it’s the right move to sign a personal guarantee to obtain that loan—make sure to do your research and weigh your options. Evaluate the terms of the loan, the terms of the guarantee, and the benefits and risks associated with signing the personal guarantee.
The better you understand the terms of your business loan, the better you can evaluate whether that loan is the right move for you, your business, and your long-term success—and if that includes signing a personal guarantee.