TABLE OF CONTENTS
- Personal Guarantees 101
- Unlimited Personal Guarantees
- Limited Personal Guarantees
- Be Sure to Read the Fine Print of a Personal Guarantee
- What’s the Risk of a Personal Guarantee?
- Release of Personal Guarantee Obligation
- The Bottom Line on Personal Guarantees
Many small business owners find that banks and creditors ask them for a personal guarantee. Becoming a personal guarantor for your company’s business loan can bolster the odds of approval, but what does it mean for you?
In this article, we’ll cover exactly what personal guarantees are and what effects they might have on your business. We’ll go over the details of personally guaranteed loans, what benefits they offer and what risks they might pose.
Personal Guarantees 101
Let’s address your first question: What is a personal guarantee?
A personal guarantee as an individual’s promise to repay credit borrowed by a business for which they are a part, either as an executive or a partner. Therefore, if the business cannot make payments on the debt, the individual who signed the personal guarantee is liable.
Understandably, personal loan guarantees improve your chances of getting approved for a loan. When you assume liability for the debt, rather than your business alone, the lender has an extra degree of assurance regarding your intention and ability to pay back the loan.
In other words, signing a personal guarantee makes you more trustworthy in the eyes of a lender. If your business cannot repay the debts incurred by the loan, your guarantee provides a safety net for the lender to fall back on.
Personal Guarantees and Limited Liability
Generally, under a limited liability arrangement, corporate debts and liabilities are not shared or assumed by the individual members of the company. However, in the case of personal guarantees, any personal guarantor of a business loan assumes personal responsibility for the debt incurred by the limited liability company of which the guarantor is an owner.
Unlimited Personal Guarantees
There are several kinds of personal guarantee loan types. An unlimited guarantee stipulates that the lender can recover the entirety of the loan amount in the event of default or business failure. Usually, this sum also includes legal fees, interest and other associated charges.
If you sign a personal guarantee and there is a business loan default, assets belonging to you or your business might be used to repay the loan to which you signed as a personal guarantor.
Lenders could pursue any of the following assets belonging to the personal guarantor:
- Personal savings
- Retirement fund
Imagine a scenario where your business borrows $100,000 from a loan for which you signed a personal guarantee. Your business pays down $20,000 but fails to make any installments after. The creditor spends $10,000 on lawyer fees to gain judgment in its favor. Therefore, you would personally be liable to repay $90,000 – the remaining $80,000 plus the $10,000 in legal costs.
Limited Personal Guarantees
Unlike an unlimited guarantee, a limited guarantee loan limits the amount of money collected from a personal guarantor. You share the burden of loan repayment with other partners in the company who have signed the guarantee.
Take loans backed by the U.S. Small Business Administration (SBA), for instance. Depending on the loan type and amount, the SBA will require individuals with a 20% or more stake in the company applying for financing to take part in the personal guarantee loan agreement. However, SBA Paycheck Protection Program loans and Economic Injury Disaster Loans up to $200,000 do not require any personal guarantee.
The varieties of limited personal guarantee loans are described at length below. These loan types have unique benefits and drawbacks that vary according to the terms agreed upon.
A several guarantee holds that each signatory on the agreement is held to a fixed share of the total liabilities incurred by the business, decided on before the loan is approved. This makes each personal guarantor aware of what amount he or she could be responsible for repaying.
A simple example, if 2 business partners agree to share an even split of the liability, then each would owe 50% of the loan if the business defaults or misses a payment.
Joint and Several Guarantee
Under a joint and several personal guarantee loan agreement, each person on the guarantee can be liable for the total incurred debt. Although the lender can recover only up to the limited amount, they can collect debt repayments from any co-signers on the agreement.
Under this scenario, it’s plausible that you might be on the hook for the liabilities agreed upon by your business partner if they aren’t able to cover their portion of the debt owed.
Before agreeing on a joint guarantee loan, ensure that you understand what you’re signing and trust the word of everyone involved.
Be Sure to Read the Fine Print of a Personal Guarantee
Unfortunately, the distinction between unlimited and limited personal guarantee loans are not so clear-cut. Keep an eye out for inconspicuous provisions in the agreement that effectively convert a limited guarantee into an unlimited one.
Be on alert when negotiating terms for a personally guaranteed loan. To protect yourself, consider consulting with an attorney or legal professional before signing the agreement.
If you default on a personally guaranteed loan, you might be responsible for providing more than only cash or liquid assets. For example, suppose you own a trucking and logistics company with an inventory of 100 trucks, and you default on a personally guaranteed loan. The trucks and other vehicle assets could be sold as a form of repayment.
Thankfully, a qualified lawyer can help you make heads and tails from what could be confusing legalese.
What’s the Risk of a Personal Guarantee?
Once you’ve personally guaranteed a business loan, you’ve granted the lender permission to claim your assets and income to make up the cost of the loan if you can’t repay it.
Many borrowers assume that repayments on a defaulted business loan can be made on the borrower’s terms. However, the real experience often doesn’t reflect this assumption.
Instead, virtually all the personal guarantor’s individual property can be reclaimed and taken to satisfy the debt. Additionally, in some cases, depending on the state, debt incurred by one spouse can be owed by both spouses.
If the lender decides to pursue legal action against you or your company for a personal guarantee business loan default, then your credit history can be negatively impacted. After your business defaults on a guaranteed loan, it’s common for borrowers to be given a court order to repay the loan amount.
Consequently, credit ratings take a hit, which can hinder your chances of securing other forms of business credit or personal credit, among other things.
Whenever possible, take precautions to ensure that the loan terms you’re evaluating are fair and equitable.
Be willing to negotiate the terms of the loan. Usually, when you meet with lenders, they’ll provide you with a standard loan agreement. This is not necessarily the final version of the agreement.
You can suggest adding new clauses or terms as you see fit. For instance, you can request that joint family or spousal assets be kept off the table.
Additionally, make sure that there are no hidden terms or questionable passages of text contained in the agreement. Be wary of overly complicated or vague language. Instead, everything should be clearly stated in terms that laypeople can understand.
Release of Personal Guarantee Obligation
In some cases, if you’re a personal guarantor and the loan goes into default, you could eliminate your obligation to repay the debt by filing individual bankruptcy (not bankruptcy on behalf of the business).
That said, if a lender has a lien on your property too, the lender could still be able to foreclose and seize collateral regardless if the personal guarantee is discharged in bankruptcy.
If you’re consulting an attorney before signing a business loan or personal guarantee agreement, request more information on this.
If a personal guarantee comes due and you’re unable to pay the outstanding debt, consider consulting with a bankruptcy attorney to determine what remedies could be available to you.
If you sell your share of the business, request a release of your personal guarantee. If the worst-case scenario arises, you don’t want to be held liable after you’re no longer part of the company. Of other note, if you’re selling your business, you may be required to pay off the outstanding debt at the time of sale.
The Bottom Line on Personal Guarantees
Personal guarantees aren’t unusual when it comes to business loans, particularly if you own a newer business or your credit has seen better days. Signing a personal guarantee can help your company gain approval for much-needed funds.
Once your business has established a good credit history, you may be able to provide collateral to get a secured loan instead, which can have more competitive rates and terms.