Wondering what it means to put a personal guarantee on business loans? Don’t worry, you’re not alone. A personal guarantee is a common feature for a loan, but to make one successfully, you’ll want to fully understand what you’re signing on for.
In this guide, we’ll cover the essential facts of personal guarantees, including what they are, why they’re important, what your alternatives are, and more.
A personal guarantee is a section of a loan contract. Under a personal guarantee, the person receiving the business loan promises to be liable for the loan amount if the business defaults. When a small business owner signs a personal guarantee, they agree to use their personal assets to pay back any outstanding debt if the business can’t.
A majority of business lenders require a personal guarantee as assurance that they will be paid back. They’re a very common method of risk mitigation for lenders. A personal guarantee is pretty difficult to avoid, especially if you’re applying for your very first business loan.
There are two primary types of personal guarantees: continuing guarantees and limited guarantees. Continuing guarantees (also called unlimited guarantees) are ongoing, meaning the personal guarantee applies for present and future loans from that lender. The parties making the guarantee are liable for the full amount of any loan, and any of their personal assets can be seized if the business defaults on the loan. But a potential benefit is the fact that the original loan can be expanded later to get new funds — without signing a new guarantee.
Under a limited guarantee, however, the guarantee only applies to the business loan in question. The business owners who sign the guarantee can only be held liable for the amount of the original secured loan. Any future loans — even term loans from the same lender — will not be held against the guarantors unless they sign another guarantee for the new loan.
Personal guarantees and collateral are both methods to “back up” your loan application; they help assure your lender that they’ll get their entire balance back. However, they aren’t exactly the same. When you sign a personal guarantee, you’re making a promise that you’ll pay back the loan — from any of your own bank accounts or non-liquid assets if you have to. But when you offer collateral, you actually offer a specific asset (or assets), usually of comparable value, that the lender can claim if you default on the loan.
For some small business owners, offering collateral can be an attractive option to control which assets are affected if they default.
A personal guarantee is basically a statement of good faith that if your business can’t pay the loan, you personally will pay back the loan balance in question. But more importantly, it’s legally binding; the grantor of the loan can demand you pay them back, even if it means you’ll have to liquidate assets to do so. They can take legal action if you don’t.
Signing an individual guarantee has a notable amount of risk, so it’s important to understand the personal consequences. For starters, a personal guarantee can have an impact on your personal credit score and your ability to get other personal loans. You might have to sell some of your assets to pay your lender if your business goes under. In extreme cases, you could even be forced to declare personal bankruptcy to pay back the entire loan you guaranteed.If you have a business with limited liability protection like a limited liability company (LLC) or corporation, personally guaranteeing a loan undermines your personal asset protection.
Signing a personal guarantee isn’t without some level of risk, but these loans can still be managed successfully. For starters, try to work with a bank that’s favorable for small business loans. Whether you go with an online lender or a traditional bank, try to find a lender that will meet your entity’s needs best.
Beyond that, you can help protect yourself by understanding what you’re signing up for. Make sure you’ve completely reviewed the terms and conditions of the loan, including the interest rate, the total of your loan payments, the repayment period, and so on. Fully understand all the loan obligations you’ll incur.
And of course, be sure to check that you’re okay with the potential consequences of a guarantee. Your business partners should be on board, too, as they might incur liability, as well. For some loan guarantors, that might mean only taking a loan they know they could pay back from their business assets. Other entrepreneurs might only take a balance they could personally pay back without too much financial impact. Depending on the risk level of your business, you might not be too bothered by an individual guarantee, but every small business owner is different.
Every lending institution (or individual) has different policies and terms for personal guarantees, but it’s often very hard to secure a loan without making a guarantee of some kind. Business lenders are most likely to require them for newer entities. After all, lenders are business owners, too; they need the financial security of knowing they’re going to make money, or at the very least, not lose money by providing your business with funds.
From the lender’s perspective, a personal guarantee is especially important if you’re a registered business with a corporate veil, like an LLC or corporation. Ordinarily, the corporate veil would protect an LLC’s owners from personal liability for an outstanding loan. But the guarantee supersedes that protection (only to the extent granted by the loan contract).
Because of that, personal guarantees are often required. But well-established businesses with assets of their own — or a proven credit history and excellent financial statements — might be able to avoid one.
In an ideal world, you wouldn’t have to complete a personal guarantee clause for a business loan in order to fund your business. But lenders need to protect their interests, too, so they frequently require them. Thankfully, you can take some steps to negotiate more favorable loan terms. Think of it from the lender’s perspective: they want the security of knowing that they’re going to be paid back. If you can reassure them that you aren’t a risky investment, they’ll be more open to negotiating terms.
For example, you might be able to get a limited personal guarantee if you provide a substantial downpayment. In some cases, offering a specific piece of property as adequate collateral might help you negotiate better terms. If you’re unsure about any of the terms in your loan contract, you can enlist the help of an attorney to help you understand and even negotiate ideal terms. This is especially helpful if you’re working with an individual lender (or other private firm).
If you’re not sure a guarantee is the route you want to take, rest assured that you don’t have to sign one to get business funding. You’ll just have more limited financing options for your small business, since most lenders require a personal guarantee. One of the top alternatives includes applying for grants, which you don’t have to pay back.
You might also be able to apply for a microloan or a small unsecured business loan without signing an individual guarantee. Usually, these loans only provide a small amount of capital to you — and as a result, they’re less of a risk for a lender. If you only need a small amount of money, a microloan might help.
If you don’t sign a personal guarantee, then there’s a good chance you won’t get as much capital lent to you. But that’s not always the case. Established businesses with a proven history of sustainable cash flow and responsible financial decisions might be able to avoid a guarantee. You can also offer up a specific asset as collateral instead of putting a blanket guarantee instead.
Starting a business can feel overwhelming, but you don’t have to do it alone. Here at ZenBusiness, we’ll help you handle the red tape so you can focus on running your business. Whether you need help starting a brand-new LLC, registered agent service for service of process, or an expense tracking tool to manage your business finances, we’ve got you covered.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Yes. If you’re a personal guarantor for your business loan and your business defaults, your creditor has a legal right to claim the outstanding balance from your personal finances.
Maybe, but it’s more challenging (and it’s harder to achieve a sizeable loan). You’re more likely to secure a loan without a guarantee if you offer up collateral. Alternatively, you can wait until your LLC has its own excellent business credit report to apply for a business loan without making a guarantee.
If you’re a member of an LLC and make a guarantee for one of the LLC’s loans, you will be held personally liable for the business debt. The guarantee becomes a “legal loophole” for the LLC’s corporate veil giving the lender additional security that they’ll be paid back.
The main disadvantage to personal guarantees for business loans is that they allow your creditor to collect from your personal assets to pay back the loan if the company defaults.
That depends on the terms of the loan in question and the type of guarantee you signed for. If you signed on for an unlimited guarantee, the guarantee applies for as long as your balance remains unpaid for all lines of credit you get with that lender. In a limited guarantee, you’re liable until the balance is paid for that specific loan.
That said, every loan agreement is a bit different, so carefully check the terms and conditions of your guarantee before signing it.
It is possible to get funding from government lenders, but often, they’re governed by strict terms. For example, the Small Business Administration requires a personal guarantee from every single member of the business who owns 20% more of the LLC or corporation.
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