Business Loan Personal Guarantee: Risks

What Is a Personal Guarantee?

A personal guarantee is a written promise that a business owner makes. He or she states that they will repay the loan using personal assets in the event their business cannot repay its debts. This loan may be secured or unsecured, which means that the lender may or may not ask for the borrower to promise certain assets as part of the guarantee.

The lender may, however, go after a business owner’s personal finances, real estate, investment accounts, or other personal assets if the business does not pay back its loan.

In essence, acting as a personal guarantee for a loan means:

What Are the Risks of Personal Guarantees?

The main risk involved with signing a personal guarantee is that if the business does not pay back its debts, then the owner will be responsible for paying back the loan using personal assets.

If the loan is large, then a business owner could lose their house, car, personal savings, or whatever other valuable assets they offered as collateral. It is important that a business owner never promises more than what he or she can afford to lose in the worst-case scenario.

If a business owner cannot repay the loan using his or her assets, then the lender can take legal action. A negative judgment can damage an individual’s credit, which will make it hard to borrow money down the road. Equifax reports that this information stays on a credit report for seven years.

If a business owner signs a joint and several liability agreements with his or her business partners, then he or she may be responsible for the partners’ share of the debt if the business fails to pay back the loan. This agreement means that a lender is allowed to collect the balance of the loan from any and all parties dependent on who has sufficient funds. This means that if the partners do not have enough to cover the debt, then the owner may have to make up the difference, which may be significant.

Also, if a business owner sells the business while it has an unpaid loan balance, then he or she must remember to have their personal guarantee released. If the owner forgets to do this and the new business owner does not pay back the loan, then the original owner may still be liable for the debt.

It can be very difficult for a small business owner to get approved for a term loan if his or her company does not have a credit history. If this is the situation, then a business lender may ask for personal assets as a sway of securing the loan. A lot of financial institutions will require an individual to sign a personal guarantee if their business does not have a documented record of borrowing and paying back loans. That said, while a personal guarantee may improve one’s chances of getting approved for a loan, it is not something that one should rush into without first understanding its implications.

Here are 10 things you must know about personal guarantees for loans:

Why Do Lenders Ask for a Personal Guarantee?

Lenders often require a personal guarantee because they need a way to analyze a business’ ability to pay back a loan. There are a lot of small businesses that do not have the necessary credit history. A Manta survey discovered that 72% of small business owners did not know their business credit score. Most business lenders will think of a business owner’s personal credit score as reflective of their business’ reliability.

The following reasons are why bank require a personal guarantee:

What Are the Advantages of a Personal Guarantee?

The primary advantage of signing a personal guarantee is improve one’s chances of being approved for a loan. It also lets the bank or lender know that a business owner is willing to risk their personal assets for the sake of their business.

It can be risky for business lenders to offer funding with no personal guarantees. This is because over twenty percent of small businesses fail within their first year. Thus, a business owner should be prepared to show that he or she is willing to take some risk. This way, a business lender will also be inclined to take a risk on the business.

Who Should Sign a Personal Guarantee?

The general rule is that any individual who possesses at least twenty percent of a business’ equity should personally guarantee any loans. If an individual is the primary business owner, then he or she is responsible for signing the personal guarantee.

Also, if an individual is married, then their spouse must also sign the personal guarantee. Lenders ask for their signature so that the owner cannot transfer any joint assets to their spouse’s name, which would free the owner from risk.

Conclusion

In the end, deciding whether or not to sign a personal guarantee comes down to a business owner’s confidence in their business’ performance, as well as the personal assets that he or she is willing to put at risk.

Signing a personal guarantee may be the only option for a business to be approved for a loan or line of credit. That said, it is still important to think about all the possible risks, as well as to discuss the idea with one’s family and business partners before signing the dotted line.