Personal guarantee is an inherent part of obtaining small business loans but there are many ambiguities and misunderstandings that surround the topic of personal guarantees.
By: Hitesh Khan/
A personal guarantee is an unsecured promise from an individual to make loan payments when a small business is not able to do so. “Unsecured” means it is a promise that is not backed up by a specific asset, such as real estate, in which case, the asset would be considered collateral.
A personal guarantee is an added assurance that you are serious about your business – and most importantly – serious about repaying the loan.
One big reason why a personal guarantee is needed is because most lenders are bankers and are in the business of accepting deposits. They use those deposits to make small business and other loans, and, as a result, they are responsible for protecting the interests of their depositors.
Be mindful that while your small business may be a borrower, you are also a depositor. As such, you would be affected if an unscrupulous small business owner borrowed your company’s deposits and did not bother to repay them.
A personal guarantee is a psychological reminder to you of your company’s obligation to make timely payments and eventually repay the loan. If it fails, you are responsible. A personal guarantee shows your commitment to being a responsible business manager and repaying your business loan.
Financial affairs of a small business are commonly intertwined with the personal financial affairs of its owners, so it is logical and reasonable to ask you to promise to repay the loan, if your company cannot. A personal guarantee offers lenders the ability to follow the due process to recover the business loan from you personally.
In essence, personal guarantee is a way to go after your personal assets, commonly your personal residence, through the legal system.
Without personal guarantee, there is not much a lender can do if your business defaults on a loan and is unable to repay it.
The good number of of small business loans require personal guarantees from business owners. This is not to say that there are no lenders who will lend without personal guarantees. Business credit-card loans are the most common example of a business loan without the personal guarantee. The rest will vary from lender to lender, and you will have to do your research to locate lenders who will not ask for or will waive the personal guarantee.
You will have a greater chance of finding lenders who might be willing to waive the personal guarantee if your company’s financial condition is strong enough to stand on its own. In addition, as your company grows in size and revenue, lenders generally will be less likely to require personal guarantees.
Business owners have to carefully review the personal guarantee agreement. You should have a lawyer or an independent loan specialist to review the paperwork for you. A typical guarantee agreement states that not only will you be liable for the loan obligations of your company, but you may also be responsible for default interest, legal, and other fees.
Always think twice about providing your personal guarantee, particularly when you do not have to. This includes situations when your business is strong financially or can offer lenders something they would want, for example significant deposits, or using other bank products and services that would generate considerable income for the lender.
If your company and you personally can bring more business to a lender than just loan income, the lender might consider waiving the guarantee. Also, think carefully about giving your personal guarantee for a business loan when you are not part of the management team and do not know what’s going on with that company.
If you do not have ownership or some other “consideration” in the company, you should not be offering your guarantee and lenders should not be accepting it. This is because signing a personal guarantee does come with risks – mainly related to your obligation to repay a business loan and the lender’s ability to go after your personal assets if you don’t. However, there are benefits. The main benefit is securing a business loan you otherwise might not get.
The key is not to obsess with the issue, but rather focus on limiting the amount of debt and making sure that your company generates sufficient cash flow to make debt payments. A personal guarantee is the reality of life for most small businesses, but it is also a decision that needs to be made with caution.
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