Personal Guarantees on Small Business Loans
A lender might ask for a personal guarantee in order to approve a business loan. Before signing that personal guarantee, a business owner should know that it may allow the bank to go after one's real estate, cash, and other assets.
Small business loans can help you take your business to the next level, whether to get your business started or to expand an existing business. Yet these types of loans are notoriously hard to get as banks are reluctant to take the risk on less established or successful ventures.
For this reason, many lenders may ask small business owners for a personal guarantee in order to approve a loan. This typically occurs when a company does not have sufficient assets or a history of making profits to qualify for a loan on its own. A personal guarantee requires that a business owner pledge they will use their personal assets to pay off business debts if the business is unable to pay the loan.
While this sounds risky, it might be what your company needs in order to qualify for a small business loan.
Why Lenders Require a Personal Guarantee
Lenders may require a personal guarantee if the business does not qualify on its own merits for a loan. Typically, this is because the company is relatively new and does not have a track record of making payments or earning profits.
A business also might not have enough assets that the bank could use in the event that the business did not pay back the loan.
The personal guarantee alleviates these concerns because the bank will have someone on the hook for the loan should the business not pay: the owner(s). However, before a small business owner signs a personal guarantee, he or she should be aware of exactly what it means.
Depending on the type of personal guarantee signed, it may allow the bank to go after his or her cash, real estate, or other assets.
Types of Personal Guarantees
There are numerous types of personal guarantees that a bank may ask a small business owner to sign in order to qualify for a loan. Understanding each type is vital to protecting yourself in a loan transaction.
Limited personal guarantees are often used when multiple business partners take out a loan for the company together. These guarantees set a dollar limit on what can be collected from the borrower in the event that the businesses default on the loan. If you are signing a limited personal guarantee along with business partners, be sure to check to see if you are signing a several guarantee or a joint and several guarantee. With a joint and several guarantee, each borrower may be liable for the full amount of the debt.
In contrast, an unlimited personal guarantee is an agreement to allow the lender to recover 100 percent of the loan amount, along with any legal fees associated with the loan. This means that the bank can go after all of your savings, including your retirement fund, your house and car, and any other assets that you have. These types of guarantees offer almost no protection for the borrower.
Importantly, there are often provisions in limited guarantees that can convert these types of guarantees into unlimited guarantees if a borrower engages in negative behavior. That is why it is important for anyone considering signing a personal guarantee to carefully review this document with their lawyer.
The Risks of Signing a Personal Guarantee
Regardless of the type of personal guarantee that you sign, there are a number of significant risks. While building your business may be worth taking these risks, it is important to be aware of what you are undertaking.
First, if your business and personal assets are not sufficient to pay off the debt, the bank could take legal action against you. If the bank secures a judgment against you, it will damage your credit, making it harder for you to borrow again in the future.
Second, you are putting your family assets at risk — including your house and other property. Some loans may require your spouse to sign as well if your property is also held in your spouse’s name.
Third, if you have partners and sign a joint and several guarantee, then you may also be on the hook for their share of the debt. That is why it is important to negotiate the personal guarantee and avoid this type of requirement.
While personal guarantees are often necessary as a way to obtain financing for small businesses, they can also be risky in terms of personal financial stability. If you plan to sign a personal guarantee, be sure that you fully understand the scope of the guarantee so that you are not putting your entire financial health at risk.