A personal guarantee on a business loan isn’t just common; business loans require it of many small businesses. Before you sign off on any loans, it is crucial to understand the ins and outs of personal guarantees to protect both your business and personal finances. Lenders also want to make sure that their finances are secure, which is why they require a personal guarantee in addition to other forms of collateral. It’s nothing personal!
Lenders just want to make sure that no matter what happens to your business, they will get repaid. So what exactly is a personal guarantee on a business loan?
A personal guarantee is a business owner’s promise to repay a business loan from their personal finances in case the business fails or can’t repay the loan for any other reason. Lenders often require business owners to provide this guarantee as a form of security. This gives lenders the peace of mind to be able to lend to small businesses, some of which may not have the credit to qualify for business loans otherwise.
There are different types of personal guarantees, the specifics of which will depend on who is lending and who is borrowing. The two main types of personal guarantees are:
Unlimited personal guarantees are usually used in the case of an individual business owner taking out a business loan. This type of personal guarantee means that the borrower themselves is responsible for repaying the loan in full if their business is not able to.
Limited personal guarantees are usually used when there are multiple business owners who ultimately share responsibility for repaying the loan if their business cannot. For example, if two people own 50% of a business they will each be responsible for paying back half of the debt remaining, if their business fails.
If they took out a $100,000 business loan and their business goes under after repaying only $50,000, they will each be responsible for repaying $25,000 respectively. Limited personal guarantees, however, often include clauses requiring one of the borrowers to pay back the full amount in case the other person cannot.
Unlike unlimited personal guarantees, however, limited personal guarantees require individuals to pay back a portion of the debt remaining if their business cannot. The amount of money the borrower will have to repay is specified upon negotiating the loan. The different types of lenders are:
- Banks and private businesses: These lenders generally require some form of personal guarantee before granting a business loan.
- The Government: The SBA loan personal guarantee requirements state that all individuals who own more than 20% of the business need to sign unlimited personal guarantees in order to receive a business loan.
How do personal guarantees work for small businesses?
To reiterate, lenders often require that small businesses sign a personal guarantee in order to receive a business loan. The purpose of this is to provide an extra layer of security to ensure that lenders will be repaid no matter what. But what does this look like in practice? If you are here, it is probably safe to assume you have assessed the amount of capital your business needs and come to the conclusion that the next step is taking out a business loan.
To start, you will first apply for a loan! Keep in mind, if there are multiple owners of the business, it is common practice for every individual who owns 20% or more to be included in the loan and will be expected to provide a personal guarantee. So even if only one of the owners wants to sign the personal guarantee on their own for whatever reason, this is generally not a possibility.
Once the application process is complete, the lenders will check the personal credit of the borrowers to ensure that they have the means to repay what they are responsible for if push comes to shove. Another important thing to note is that personal guarantees are usually in addition to loan collateral, like property.
Meaning if, in the worst case scenario, your business fails and the lender forecloses on the loan collateral and there is still money left to be repaid, any and everyone who signed the personal guarantee will be personally responsible for paying off the remaining debt.
Signing a personal guarantee also means the lender can sue the borrower if they are unable to pay, sometimes resulting in the sale of personal property to pay off the loan, leading to significant personal liability.
While this scenario might sound scary, one of the perks of signing personal guarantees is that the business owner is not expected to provide any more up-front in order to receive the loan.
In other words, so long as your business stays afloat, you have nothing to worry about.
What are the requirements for limited personal guarantees on a business loan?
If a personal guarantee is required by the lender, it is usually built into the business loan application process. It is actually quite simple to complete a personal guarantee, which might be misleading given the potential consequences. Be aware that your individual liability on the business debt will be significantly higher once you provide a personal guarantee.
We touched on how a personal guarantee works but let’s discuss the requirements. After filling out the loan application, you and any other guarantors will undergo a credit score check. It is crucial to have trusted business partners to share the burden of responsibility when signing personal guarantees, as this can impact not only the financial risk involved but also the approval process for securing a loan.
Now there are a couple of important notes about personal guarantees and credit scores.
First of all, if anyone listed on the loan application does not have a good credit score, this could lead to the business loan being denied.
The loan being denied could also be the outcome if a business cannot put up enough collateral or does not have a clear sales plan to generate enough funds to be able to repay the loan.
Second, any business loans will be visible on the business owner’s credit report after signing a personal guarantee. If for any reason the loan cannot be repaid this will have a negative effect on the credit score.
Assuming all goes well with the credit check, the next step in the business loan process is negotiation. This is where all the details of the loan and personal guarantee are determined; whether or not it will be a limited personal guarantee or unlimited personal guarantee, the cap on the limited personal guarantee, and so on. The final requirement for personal guarantees and business loans is signing all the documents, and voila you’ve got yourself a business loan.
Can I get a business loan with no personal guarantee?
While it is rare, there are some business loans that do not involve personal guarantees. This is called an unsecured business loan. Business credit cards are another option, as they typically assess the creditworthiness of the business rather than the personal credit of the owner.
In unsecured business loans, a lender cannot go after the borrower’s personal assets even if their business fails. If a business defaults, the lender will be able to foreclose on the collateral and resell it in hopes of making as much of their money back as possible.
How to get a business loan without a personal guarantee, you ask?
Personal finance experts often provide guidance on this topic. Unsecured business loans are riskier for the lender for obvious reasons but they are not unheard of. The Small Business Administration mandates unlimited personal guarantees from business owners who possess a significant ownership stake when applying for SBA loans. A lender might be able to acquire a non-recourse loan by offering a large sum of money for a deposit or some other form of credit.
