How Personal Guarantees Work for Business Loans
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Often times when you go to try and get a small loan for your business, you're faced with having to offer a personal guarantee. Should you do it? How can this affect both you and your business? Below we review the nuances associated with the personal guarantee when it comes to applying for a small business loan.
What Exactly is a Personal Guarantee?
Essentially, you can look at a personal guarantee as your promise to repay the loan should the business default. So as the company owner, upon signing a personal guarantee, you are thus on the hook if the company cannot repay its debt.
Because you are saying that you will be personally liable, this does help your chances of being approved. Especially if you are a relatively new company and have not yet had time to build up business credit, leveraging your personal credit by way of such a guarantee can help you in the long run. This simply gives the lender you are working with an extra layer of protection in the event of a default.
If your company happens to be a corporation and you have limited liability protection, upon signing a personal guarantee you are making yourself more vulnerable and thereby nullifying some of that protection.
Generally speaking, with a limited liability arrangement such as can be seen with LLCs, LLPs, S Corps an C Corps, the business's debt and liabilities do not fall back on individuals; however, if you sign a personal guarantee you are in essence taking direct responsibility for the loan.
Different Types of Personal Guarantees
Personal guarantees can come in a few different forms. First off, you have the unlimited guarantee—as the name suggests, by signing this you are going to be held responsible for the entire debt. This may also involve any legal fee or other such costs that eventually come to be associated with a business loan in default. Furthermore, depending on the severity of the situation, your business can actually be faced with legal action unless they take your assets to repay the debt. Such assets might include your home, vehicles, savings, retirement and anything else of this nature.
There is also a limited guarantee loan; this would effectively limit what they could take from you in the case that your company cannot repay the loan. According to the SBA, if anyone owns 20% or more of the company they would then have to sign off on this personal guarantee. As far as the limited variety of guarantee goes, there are two kinds to be aware of:
With a joint guarantee, all parties who co-sign are liable. And while yes, only a limited amount can be collected, if your business partners do not have the assets to cover their share, you may be liable for their part as well. If you do opt for this type of guarantee you need to make certain that everyone is on the same page, and everyone will, in fact, assume responsibility for their portion.
Several guarantees are basically opposite that each person who signs is responsible for a fixed amount. So let's say two partners choose to go fifty/fifty, then that is all each of them would owe if the loan defaulted.
What to Know About Borrower Fraud
Unfortunately, not all lenders are above board when it comes to getting clients to sign personal guarantees. And while you may think you're signing a limited guarantee, they have underhanded ways of flipping it into an unlimited one. With hidden clauses and less-than-transparent provisions, such lenders sometimes are able to slip these details right past borrowers. It is always a good idea to talk to an attorney prior to signing any such agreement.
Predatory clauses may also include more than just your cash or personal assets. Let's say for instance that you have a company with a number of substantial pieces of equipment. If you default and then your personal assets do not cover the loan cost, it may be on you to help sell off the equipment so that the lender can recoup their money. Lawyers are adept at uncovering such clauses and thus making you aware of exactly what you're signing up for.
Risks to Be Aware of
Obviously, there is going to be risk associated with signing any kind of personal guarantee. You are basically saying that it is okay for the bank to take your assets or potentially even garnish future wages should your company default on its loan.
Literally, everything you own can be taken away under the terms of many a personal guarantee. Again, this is why ensuring that a lawyer looks everything over is a good idea. Even then though, keep in mind, the signing will allow personal property and assets to be reclaimed and or repossessed.
Not to mention, there also may be legal ramifications if the company cannot repay the debt and you've signed a personal guarantee. After the company officially defaults, it is not uncommon for the guarantor to be served with a court order of repayment. Plus, your credit will most likely take a drastic hit. Keep in mind too, if you are married your spouse's assets, as well as his/her credit score, will also be impacted. This is something which can seriously diminish the quality of your family's life.
How To Mitigate Some of the Risk
You want to be a careful negotiator when it comes to your loan terms—if you're unsure of your capabilities then hire a representative to negotiate on your behalf. You will most likely be offered a standard loan agreement; you can, however, ask for changes, additional clauses, and other such details that make the loan better suited to your needs. Always look for any hidden terms or "surprise" clauses. Everything should be crystal clear; if anything seems too vague ask for clarification. In terms of a personal guarantee, you can also ask if it's possible for your spouse's assets to be excluded.
Understandably, signing a personal guarantee is a big deal. There is risk involved; you could stand to lose valuable possessions. This is why ideally, such a step would be the last resort. Work on building your business's credit. Or you could also look for available collateral to put down. If possible, stay away from such guarantees.