Very often when a small business owner takes out a business loan, be it for purchasing equipment or for a line of credit, they will have to sign a personal guarantee. Guaranteeing a loan in this manner is fairly common practice. And for many lenders, it is a standard component of a business loan agreement. It gives the lender greater security and a means of recovering funds should the business default. That said, there are certain things that you definitely need to be aware of when guaranteeing a loan. In this article, we look at what's involved with a personal guarantee and how it could potentially impact you.
Understanding Personal Guarantees
Basically, a personal guarantee stipulates that you are personally responsible for the money owed in conjunction with the commercial loan. So if the business for whatever reason cannot pay it back, then you will have to repay the balance of the debt. This is done so that there is less risk involved with the loan itself. That is to say, the lender now has a means of recouping the money even if the business fails and defaults on the loan. In many cases, guaranteeing a loan is necessary, especially when dealing with smaller businesses that don't have a long credit history.
Now, that said, there are of course risks associated with guaranteeing a loan. You should always go into any loan agreement confident that the business will have the means/longevity to repay the debt. Otherwise, you could be looking at a substantial financial burden. As with any sort of legal agreement, a personal guarantee is enforceable.
When reviewing a loan application, lenders will generally look at the credit history of both the business and the owner of the company. If credit scores are too low in either capacity, this could deter the bank from approving the application, as the personal guarantee won't mean as much coming from someone with a weak financial track record. The better the credit scores (of both the business and guarantor/) the better the chance of procuring business loan financing.
Why Many Lenders Require a Personal Guarantee
Beyond helping to mitigate risk, there are several reasons why lenders very often require personal guarantees.
- It shows your level of commitment in terms of repayment; meaning, if a lender sees that you are willing to be personally invested in the loan, they will be more willing to take a chance on you.
- As noted, the risk is mitigated when the owner guarantees a loan. The lender has the ability to seize personal assets in an attempt to recover their losses. Of course, the wording of the personal guarantee agreement comes into play here. But almost always, the lender will go after a business owner's personal assets in the case of nonpayment.
- If you are a smaller business with revenue below a certain point, the personal guarantee gives the lender access to more money/assets.
Types of Personal Guarantees
Unlimited personal guarantee
As the name suggests, with an unlimited personal guarantee, the lender can go after 100% of the loan amount. This also includes legal fees that could arise as a result of any action they might have to take in an effort to collect on the debt. So for example, the lender could conceivably go after your personal home, retirement accounts, vehicles, any relevant assets. Some states do have protections in place to this end, so your home, depending on your state, could actually be safeguarded from bank seizure.
Limited personal guarantee
With a limited personal guarantee, there is a set amount in place per the agreement, of what the lender can recover if you do default on a loan. They can therefore only take in assets totaling the amount/percentage stipulated. If a company has multiple owners, a limited personal guarantee is often used.
Things to Be Careful Of…
Any business loan is a commitment; that said, you should do everything you can to honor that commitment. If you do default on your loan, the impact could be significant, and it could trail you for years to come. Lenders want to ensure that you are serious about the longevity of the business and that you understand exactly what could happen if you cannot repay your loan.
Keep in mind, that while loans with a personal guarantee can cost less in terms of interest and fees, there are certain risks and drawbacks to be aware of prior to signing on the dotted line. It can be difficult if not impossible to get out of a personal guarantee even if you sell the business. You must ultimately be released from the guarantee. The other way would be to declare personal bankruptcy, but this of course has a hugely detrimental impact on your credit and consequent ability to apply for any type of loan in the near future. Even if the business files for bankruptcy, usually unless you are a sole proprietor, you are going to have a personal bankruptcy to get out of the guarantee.
And as previously discussed, by guaranteeing a loan you are putting your financial future at stake should the business be unable to repay the debt. You become personally liable and your assets are at risk. Most often a personal guarantee comes into play when the business is small and there is little credit history available. This way the lender has at least some security in place.
First Union Lending works with small companies across the nation. We want to help you make it through this challenging time. With short term loans, lines of credit, and merchant cash advances among other loan products, we have a solution for you. We custom tailor our loan programs to suit your specific needs. So whether you're looking to expand, launch a new product or hire more staff, the funds are available. Some clients receive money within two business days. Call today and let's get started together.