Taking out a loan might help your company stay afloat and grow, but there's one caveat: lenders may need a personal guarantee.
If you wish to qualify for company finance, you should expect to sign a personal guarantee in most circumstances. Lenders frequently want a personal guarantee, while it is not always needed, as further assurance that any money they give you will be returned. However, before you sign, be sure you understand exactly what you're committing to.
Table of Contents
- What is Personal Guarantee?
- Examples of Personal Guarantee
- Impact of Personal Guarantee on Small Business Owner’s Personal Finances
- Need for Personal Guarantee for Some Business Loans
- 6 Simple Steps to Provide a Personal Guarantee
- Advantages & Disadvantages of Personal Guarantee
- Types of Personal Guarantees
- Alternatives to Personal Guarantees
- How Does Personal Guarantee Works?
- Final Words
- Key Takeaways
Let’s understand this topic in-depth in this article.
What is Personal Guarantee?
A personal guarantee is exactly what it says on the tin. If your firm fails to pay the business loan, it gives your lender the ability to seek your (the guarantor's) personal assets.
Small business lenders have realized that the financial health of a small business and the financial health of the small business owner are linked in various circumstances. This is one of the many reasons why personal guarantees are required by traditional lenders, the SBA, and many internet lenders.
According to the SBA:
“For all SBA loans, personal guarantees are required from every owner of 20% or more of the business, as well as from other individuals who hold key management positions. Whether a guaranty will be secured by personal assets or not is based upon the value of the assets already pledged and the value of the assets personally owned compared to the amount borrowed.”
“This assures that the borrower has adequate personal interest at stake in the firm," most lenders, including the SBA, agree. And they will do everything possible to make each and every recurring payment till the loan balance is paid in full.
By committing to a personal guarantee, the company borrower agrees to be personally liable for repayment of the whole loan amount, as well as any collection, legal, or other charges associated with the loan.
Examples of Personal Guarantee
- When a minor is using a stock trading or charting site, personal guarantees from an adult guarantor are frequently required. Another situation is when a person obtains immigration status in the nation, in which case trading platforms frequently need a personal guarantee from a citizen or permanent resident of the country.
- Another example of a personal guarantee is a corporate credit card provided to an individual. The person or employee is accountable for the debt that the company incurs as well as the total credit card expenditure. The cardholder acts as a guarantor in this situation.
Impact of Personal Guarantee on Small Business Owner’s Personal Finances
Be careful as a lender, if you personally guarantee a small business loan and the firm fails to make timely monthly payments, your personal credit rating will certainly suffer as a result. This might also apply to a small company credit card or other forms of debt.
Following is the statement about the impact of personal guarantee, according to SBA and other lenders:
“Your personal guarantee survives most events, such as selling your interest in the company. In other words, if you’ve signed a personal guarantee and you sell the business, your guarantee may still be applicable should the business fail to meet the obligation. However, you may be able to be released from your personal liability by asking the lender to do so (e.g., you may be able to substitute a personal guarantee by the new owner). Alternatively, try to have the company satisfy the outstanding obligation before you sell your interest so there’s no longer anything that you still personally guarantee for the company.”
As a small business owner, if you believe this is a circumstance you may encounter in the future, you should speak with your lender about it.
Need for Personal Guarantee for Some Business Loans
People don't often seek a business loan with the purpose of not repaying it. However, not all businesses prosper, and as a result, not all debt taken on by enterprises gets repaid. Lenders are aware of this, which is why personal guarantees were developed.
A personal guarantee is a legal pledge made by an individual to repay credit granted to their company with their own personal assets if the company fails to repay the loan. Personal guarantees on business loans are often unsecured loans since they are not backed by your company's assets, such as commercial property or inventory.
During the loan application or approval procedure, a personal guarantee is frequently signed. Small business owners frequently employ a personal guarantee since they are personally committed to the success of their company. Plus, they might not be able to get a loan if they don't have one.
A creditor has a legal claim on the guarantor's personal assets under a personal guarantee. Checking and savings accounts, automobiles, real estate, and other liquid assets are examples. A small business owner who wants to give a loan guarantee will usually have to disclose their own credit history and financial background, as well as their company's credit information.
If you have a lot of personal assets, a personal guarantee reduces the lender's risk, which can lead to greater credit and better conditions, such as reduced rates. Financing without a guarantee may be possible for well-established enterprises with a long credit history.
6 Simple Steps to Provide a Personal Guarantee
Although signing a personal guarantee might significantly raise your obligation when applying for a loan, the process is actually rather straightforward. If a personal guarantee is required for a loan, it is usually included in the application. The steps for establishing a personal guarantee are as follows:
Step 1: Apply
Fill out the whole loan application and include all of your personal details.
Step 2: Assemble your paperwork
For evaluation, including your personal financial details, including any interests outside of the company requesting the loan.
Step 3: Examine your files
Any outside company interests' financial records may need to be reviewed.
Step 4: Examine your credit report
Complete a credit check, either hard or light.
Step 5: Set everything up
Negotiate a personal guarantee that is either restricted or infinite.
Step 6: Sign
All loan documentation, including liens and guarantee agreements, must be signed.
The lender can lead any necessary guarantors through the underwriting and signing procedure, regardless of the sort of company loan you're looking for. Borrowers will not be asked to do anything other than giving desired information and sign the relevant paperwork.
Advantages & Disadvantages of Personal Guarantee
Accepting a personal guarantee is a difficult decision. It's worth thinking about, though, because it might open up doors that were previously closed to you.
- Increasing your chances of receiving funding
You're providing the lender with extra security by signing a personal guarantee. This might be the push they need to give you a loan.
2. Obtain your company's objectives
Signing a personal guarantee can assist you in obtaining the funds you require to achieve your objectives, such as your next step of development. If you've been turned down elsewhere, this might be one of the only opportunities to help your company reach its full potential.
Understanding the possible implications should also play a significant role in your decision-making
1. Future unpredictability
Even if you're convinced that your company will be able to make the payments, things may not go as planned. The unexpected may happen in business, and it often does.
2. It's a personal affliction
It will be your obligation to step up and make the repayments if your firm goes bankrupt. And if you're not in a position to do so easily, it might lead to long-term financial issues, such as bankruptcy.
Types of Personal Guarantees
Let's look at the two sorts of personal guarantees: unlimited and restricted guarantees, now that we know what a personal guarantee is.
1. Unlimited Personal Guarantees
When you sign an unlimited personal guarantee, you agree to allow the lender to reclaim 100% of the loan amount, plus any legal expenses related to the loan, by any means necessary.
If your business fails or you default on your loan for any reason, your lender can hire lawyers to obtain a judgement in their favour, then go after your life savings, retirement, college fund for your children, home, car, and any other assets they can find to cover the full cost of the loan, plus interest and legal fees.
If you still owe $30,000 and default on the loan, and your lender pays $3,000 in court expenses to obtain a judgement in their favour, you will owe $33,000, which may be lawfully taken from any area of your resources to repay the loan.
There's a reason these guarantees are dubbed "unlimited." They provide little to no financial security to you, the borrower, if your firm isn't as profitable as you had hoped.
2. Limited Personal Guarantees
Limited personal guarantees, on the other hand, impose a financial limit on what may be retrieved from you as the borrower if you default on your loan.
When a group of business partners takes out a loan for the firm, limited guarantees are frequently employed. According to SBA guidelines, anybody with a 20% or larger ownership in the company should be included in the guaranteeing process. If the firm defaults on a business loan, these guarantees help define each person's share of the debt pie.
Limited assurances, on the other hand, come with their own set of issues. Check if you're signing a joint and several guarantees or several guarantees with your company partners before agreeing to sign a limited guarantee.
Each party has a fixed percentage of respondents with multiple guarantees. You'll know upfront what the highest amount you may owe in the worst-case situation is, which will be a defined percentage of the loan—usually proportional to your ownership interest in the firm.
After an in-depth study about what a personal guarantee is? Its advantages and disadvantages. And its types; let’s see what other alternatives are present for the small business owners.
Alternatives to Personal Guarantees
A personal guarantee is one of the ways in which a lender may safeguard their investment. You have alternative possibilities if you don't want to jeopardise your own assets. Of course, no loan is ever completely unsecured, so you'll have to secure your loan in one of the ways listed below.
Blanket Corporate Lien
A blanket corporate lien is similar to a personal guarantee, except it applies to your company's assets rather than your personal ones. It's a frequent legal allegation included in virtually all small company loans' fine language. Lenders can sell a business's assets to recover money owing to them when they file liens for outstanding debts.
You might be able to get a collateralized loan if you have anything to put up as collateral. A single item or collection of assets that guarantee a small company loan is known as collateral. If a firm fails to make regular loan payments, lenders can get a court order to seize and liquidate that specific asset from the borrower to repay the loan.
Loans with personal guarantees or blanket business liens are considered unsecured, whereas loans with collateral are considered secured. In general, it's preferable to put up collateral for a loan rather than risking all of your personal and corporate assets with a personal guarantee or lien. Real estate, merchandise, cash, and outstanding invoices are all examples of traditional collateral.
How Does Personal Guarantee Works?
In order to get money for enterprises, personal guarantees are employed in credit agreements. They are utilised by new and small firms—generally, for enterprises that aren't as well-established or for those who don't have enough credit history to qualify for loans and other forms of credit on their own. When the firm's principals sign a personal guarantee, they promise their own assets and undertake to repay a debt from personal funds if the company defaults. In other words, the firm owner or principal signs the credit application as a cosigner.
This is how it goes. If the firm is too young or has a negative credit history, lenders may ask business owners or executives to submit a personal guarantee in order to obtain financing. As part of the loan application, the business owner submits their own credit history and profile, which serves as the primary foundation for underwriting. When a personal guarantee is utilised, the applicant provides their Social Security Number (SSN) as well as information about their personal income for a hard credit check. In addition to the company's employer identification number (EIN) and financial records, this information is provided.
As part of their personal guarantee, an executive may also promise their own personal assets—checking accounts, savings accounts, automobiles, and real estate—and commit to repaying a loan from personal resources if the firm defaults. This not only makes financing more available to companies, but it also reduces the risk for creditors, as they now have a legal claim to the individual's personal assets. It also enhances the conditions in the underwriting process, which will be based on the profile of both the business and the person.
Small business founders and executives typically invest a significant amount of their personal money in the beginning. One of the reasons they give personal guarantees to obtain loans is that they have a strong interest in the start-up and growth of their companies. As a result, instead of creating a return for equity investors, firms may be compelled to pay creditors monthly instalment payments.
Before agreeing to any type of personal guarantee, you must honestly assess your business and finances, acknowledging the actual potential that, despite your best efforts and intentions, your firm may collapse. Consider how each clause in the agreement could affect your business and personal finances in the future. Finally, you must decide whether the risk is worth the return.
In an ideal world, you'll pay off all of your company's obligations on schedule and in full, and you won't have to worry about your personal assets being used. Even if something unexpected occurs, you should have a contingency plan in place to guarantee that your debt is paid. If you don't, you might want to put your loan search on hold until your finances have stabilised, so you don't end up risking your business or personal assets.
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- A personal guarantee gives your lender the ability to seek your (the guarantor's) personal assets if your firm fails to pay the business loan.
- By committing to a personal guarantee, the company borrower agrees to be personally liable for repayment of the whole loan amount, as well as any collection, legal, or other charges associated with the loan.
- Personal guarantees on business loans are often unsecured loans since they are not backed by your company's assets, such as commercial property or inventory.
- There are 2 types of Personal Guarantees: Limited and Unlimited
- Collateral and Blanket Corporate Lien are the two alternatives for Personal Guarantee