Understand the Impact of an Unsecured Personal Guarantee on a Business Loan

Loans are a great financial tool for small business owners wanting to start or grow a business. Choosing the right type of business financing is important to all small business owners because business debts impact a company’s long-term financial health. But if they aren’t managed properly, they can hurt a business’s creditworthiness.

During the loan application process, there are many decisions a borrower faces. These include whether to provide collateral or a personal guarantee, how much they should pay upfront, and what type of repayment terms fit their budget.

Many business owners get unsecured loans with personal guarantees without knowing what the consequences could be.

Let’s explore the pros and cons of providing a personal guarantee on an unsecured small business loan.

What is an unsecured business loan?

An unsecured business loan is a type of business financing that doesn’t require collateral like real estate or equipment. Because of this, lenders have stricter rules to approve the loan.

Qualifying for an unsecured business loan often requires an excellent personal and business credit score and a solid business history. The reason unsecured business funding requires higher credit scores is there’s no collateral to recover if you don’t pay the loan back. Whether you apply with a bank, credit union, or other lender, the loan amount with a personal business loan likely won’t be as high as with a secured business loan.

With a secured loan, you offer collateral as a promise to repay. If you can’t pay, the lender can take the collateral.

Lenders can take several actions if the borrower defaults. These include:

• Turn the loan over to collections
• File a lawsuit against the borrower
• Report the default to credit agencies
• Garnish the borrower’s wages
• Place a lien on the borrower’s personal assets

Types of unsecured business financing

Many types of business financing offer both unsecured and secured options:

Short-term loans

Term loans are a traditional type of small business financing. With term loans, a borrower is approved for a loan amount and receives a lump sum upfront. Then they make monthly payments until the loan is paid off.

Both secured and unsecured short-term loans can be good solutions for borrowers who need funds for a large purchase or for working capital.

Advantages of term loans include:

• Predictable repayment terms
• Potentially low-interest rates
• The option for either fixed rates solutions or variable interest rates solutions, giving you flexibility for your specific situation.

Merchant cash advances

A merchant cash advance (MCA) is a type of fast funding that offers you a cash advance in exchange for a percentage of your future revenue. You repay the funding with weekly or monthly payments.

MCAs work best for:

• Business owners with bad credit
• Borrowers with no business credit history
• Borrowers who don’t qualify for unsecured financing
• Borrowers who have trouble getting approved for traditional business loans

Business lines of credit

Unsecured lines of credit provide revolving credit to small business owners. Business lines of credit work like business credit cards. A borrower is approved for a maximum credit limit. Then they can draw on funds when needed.

With a line of credit, you only pay back the amount you’ve withdrawn. The amount of credit that’s repaid can be withdrawn again from the credit line.

A business line of credit is great for:

• Maintaining cash flow during slow seasons
• Making large business purchases
• Meeting unexpected business expenses
• New business owners wanting to build an excellent credit history

What is a personal guarantee?

A personal guarantee is a promise by a borrower to repay a full loan amount. The guarantee is a document you will sign during the financing application and it ensures the lender you’ll personally pay off any portion of the loan the business can’t. Personal guarantees are unsecured since they aren’t linked to collateral. They’re more common with term loans and SBA loans, which are partially guaranteed by the U.S. Small Business Administration.

Types of personal guarantees

There are different levels of personal guarantees in terms of liability. It’s essential to understand what type of guarantee a lender requires.

• Limited personal guarantee - A limited guarantee lists a specific monetary amount the financial institution can legally claim from the borrower. Limited guarantees are common in small businesses structured as partnerships since both partners share part of the loan repayment responsibility.
• Unlimited personal guarantee - In an unlimited guarantee, the lender can go after the guarantor for the entire amount owed in a default. This includes interest, legal fees, and financing costs on top of the loan. Very few personal assets are exempt from a lender if a borrower signs an unlimited guarantee.
• Indemnity - Occasionally, business lenders ask for an indemnifier instead of a guarantor. An indemnity is a primary obligation that states the indemnifier must repay the lender if the company can’t or is in breach of contractual terms.

The pros and cons of using a personal guarantee

When small business owners sign a personal guarantee or asks an interested party to become a guarantor on the business’s behalf, they accept personal liability for the borrowed funds. There are pros and cons to providing a personal guarantee.

Pros of an unsecured personal guarantee

There are many benefits of providing an unsecured personal guarantee. These include:

• Improved chances for a lower interest rate since the loan requires good credit
• Smaller down payment requirements

Even with an unsecured personal loan and guarantee, the lender has a lower risk because they’ll only loan money to low-risk loan applicants. Many borrowers prefer an unsecured personal guarantee business loan over providing collateral. This is because guarantees aren’t linked to a specific asset like secured loans are.

Cons of an unsecured personal guarantee

There are risks and disadvantages to providing an unsecured guarantee. These include:

• A higher personal risk to the business owner
• Personal liability for the debt, which can be overwhelming
• The risks of losing personal and business assets

How to minimize risk when providing a personal guarantee

If you’re the personal guarantor on a personal business loan, you already know the risks involved. However, there are steps guarantors can take to minimize that risk when reviewing loan offers.

• Communicate - Don’t hesitate to reach out to your lender with questions about your responsibilities as the guarantor. Some lenders work with borrowers to change loan terms, defer payments, or offer refinancing options. For example, even if you’re wondering, “Where can I find my business loan terms,” your lender will be able to help.
• Personal Guarantee Insurance - Insurance can reduce the financial risks of a personal guarantee. It can also minimize the risk to your personal finances. Insurance covers up to 80% of your liability if you fail to repay the loan.
• Customize - Personal guarantors can request to eliminate specific assets from the guarantee. For example, you can ask that the paperwork be amended to prevent an asset, like your home, from being seized in the event of default.
• Choose co-guarantors carefully - Some entrepreneurs don’t own enough personal or business assets to provide the personal guarantee independently. So, they seek a co-guarantor. The co-guarantor of a loan can be the small business owner’s spouse, investor, family member, or friend. It’s important that whomever you choose as a co-guarantor can carry their portion of the responsibility.
• Consider higher interest rates - Signing a personal guarantee is a huge step for borrowers. It can be very risky to their financial well-being. An alternative to providing a guarantee is to talk with the lender about eliminating the need for the guarantee and raising interest rates instead.

How to get financing without a personal guarantee

If you’ve decided that providing an unsecured personal guarantee is too much of a risk for your business or for your personal finances, there are ways to secure business financing without becoming a guarantor.

• Consider offering collateral - If you feel uncomfortable with the liability of a personal guarantee, consider a secured loan. Secured loans require collateral as a guarantee the lender can recover the loan funds.
• Work with alternative lenders - Alternative lenders or online lenders work with several financial institutions at a time. They also have a wide variety of loan products to offer borrowers.
• Research alternative financing options - Explore other funding options like crowdfunding or government grants if you can’t qualify for an unsecured business loan.

Final Thoughts

Signing a personal guarantee is a great way for small business owners to get financing through a personal business loan at a competitive rate, but can be risky because they put your assets at stake.

FAQs about

What is a personal business loan?

A personal business loan is sometimes called a personal guarantee business loan because it doesn’t require collateral. Personal business loans are a type of unsecured financing for business expenses. Most personal business loans require good credit, with loan funds distributed in a lump sum and paid back in equal monthly payments.

Is it better to get a personal loan or a business loan for a small business?

The answer depends on your business goals, the terms offered, and what your goals are. If you're buying equipment, you might be better off taking out a business equipment loan with the equipment as collateral so that you don’t risk your own assets or reputation should you default. But if you have good credit and can get an unsecured business loan with a decent annual percentage rate, it might make sense for you.

How do I apply for a personal business loan?

To apply for a personal business loan, most lenders will want to see your business plan, one to two years of tax returns, bank account ledgers, profit and loss statements, and cash flow statements. Before applying, review the lender’s eligibility requirements to ensure you meet them. Once you have your business plan and all required documentation, you can begin the application process.

How much can I borrow with a personal business loan?

Because personal business loans are unsecured, you’re not likely to get as much as you can with a regular business loan. The amount you can borrow will vary from lender to lender. But you may find lenders willing to offer you $100,000 or more.

What are the eligibility criteria for a personal business loan?

Lenders require excellent credit, solid financial statements, and enough cash flow to support the loan.

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