What Is A Personal Guarantee?

As a small business owner, you’ve probably been asked to sign a personal guarantee when applying for financing. But what is a personal guarantee? Should you sign one? And what does signing one mean for you and your business?

Here is the complete guide on understanding personal guarantees.

What Is A Personal Guarantee?

A personal guarantee is an agreement that promises if a business cannot finish repaying a loan, the guarantor(s) is responsible for repaying the loan with their personal assets.

Simply put, a personal guarantee is a promise that you will be responsible for repaying your business loan even if your business cannot do so.

What Is A Guarantor?

The person(s) signing a personal guarantee that owns at least 20% of the business and agrees to cover the payments if the business cannot.

While the business owner(s) are most often guarantors, a personal guarantee agreement is also commonly signed by a loan cosigner and the spouses of all guarantors.

How Does A Personal Guarantee Work?

This type of agreement is commonly required when a guarantor borrows capital from a bank, credit union, or online lender and also applies to many business credit cards (it’s not always clear who is responsible for business credit card debt).

It’s important to note that a loan with a personal guarantee is not considered a secured loan because the agreement is not tied to any specific assets/collateral. Many lenders that advertise “unsecured loans” (versus secured loans) still require a personal guarantee.

Although signing over possible rights to your assets is daunting, there are a few good reasons to sign a personal guarantee.

However, personal guarantees still give a lot of power to lenders. The good news is that there are different types of agreements, and some of them offer more protection for you and your business partners than others.

Keep reading to learn more about the differences between the two types and avoid a bad agreement!

Why Lenders Require Personal Guarantees On Business Loans

A personal guarantee makes it much more likely that the lender will get their money back.

When you sign a personal guarantee, it proves to the lender that you are fully invested in repaying the money you are borrowing. The guarantee also ensures that the lender will have legal recourse to pursue their money if you don’t repay.

Lenders that require personal guarantees can also offer better rates and fees than they could with a fully unsecured business loan. Because they are more confident that they’ll get their investment back, they feel more confident advertising competitive rates that appeal to prospective borrowers.

Types Of Personal Guarantees

Typically, personal guarantees are divided into two categories: unlimited and limited agreements. Here are the basics of each one:

Unlimited Personal Guarantee

If you are a guarantor on an unlimited agreement, you are giving the lender permission to collect any money you still own them plus any legal fees that might have incurred while the lender was securing a judgment against you.

For example, if you still owe $40,000 on your loan and it costs the lender $8,000 in legal fees to get a judgment against you, you will owe $48,000.

An unlimited guarantee is often extended to single-owner businesses. While this type of guarantee does not offer a lot of protection, there is a possibility you can negotiate with your lender to place limitations on the agreement.

Limited Personal Guarantee

Limited guarantees are used when multiple business partners are signing for a loan; this may happen depending on the structure of your business. There are two different types of limited guarantees: several guarantees and joint and several guarantees.

If you and your partner(s) sign a joint and several guarantee, each guarantor is responsible for the full amount of the loan. As you can imagine, this type of agreement could lead to problems between you and the other guarantors if something should go wrong.

On the other hand, a several guarantee means that you and your partner(s) are responsible for a set percentage of the outstanding capital and legal fees. Normally, the percentages correspond to how much of the business each partner owns.

A several guarantee is more desirable in a scenario with multiple business partners because each partner knows (and agrees to) how much they’ll be responsible for ahead of time.

What Is Required For A Personal Guarantee?

Nothing is strictly required of a guarantor other than writing your signature on the dotted line. However, it’s smart to perform due diligence before signing. This means making sure you understand the terms of the guarantee and possibly even negotiating those terms, with the help of an attorney.

Personal Guarantee VS Business Collateral

A personal guarantee differs from business loan collateral in some important ways.

Though the net effect of a personal guarantee is basically the same as collateral, (you are incentivized to repay your loan so that you don’t lose your assets), business collateral and a personal guarantee differ in one notable way: Business collateral is limited to your business assets, while a personal guarantee is tied to your personal assets.

A loan secured by business collateral can include specific collateral, such as business property, or it may be secured with a blanket lien, which includes all of your business assets.

If you default on your secured loan, the lender can seize whichever business assets you pledged (or, in the case of a blanket lien, all of them), but they cannot touch your personal assets unless you have also signed a personal guarantee. You should be aware that most loans that require a blanket lien will also require a personal guarantee.

Another difference between business collateral and a personal guarantee is that a loan secured by business collateral triggers a UCC filing notifying creditors that there is a lien on your business. This filing will show up on your credit report and make it difficult for you to obtain a second loan until you pay off your secured loan and get the lien removed.

A personal guarantee, however, will not trigger a UCC or show up on your credit report so long as you don’t default on the loan.

How Personal Guarantees Can Affect Your Business

So what happens if you sign a personal guarantee? As long as you repay the money you borrow by the end of your term, nothing! Still, you need to think about what will happen if you can no longer repay your loan. Nobody ever wants or plans to default on a business loan. Sometimes, however, it’s unavoidable.

Here are the two scenarios that can happen if you default on your loan with a personal guarantee:

Should You Sign A Personal Guarantee?

Chances are, if you want a business loan, the answer is yes. Very few business lenders offer financing without a personal guarantee. Those that don’t require the agreement often charge high-interest rates or fees.

That doesn’t mean you should sign any personal guarantee that comes your way, though. Carefully read over the terms of the agreement and, if possible, seek the expertise of a legal professional. If the terms of the contract are not acceptable, there is a possibility that you (or a professional on your behalf) can negotiate the terms of the agreement. You might be able to suggest terms of relief for when you’ve paid off a certain amount of the loan, leave your spouse or co-signer out of the agreement, or make other arrangements that might offer you more protection.

Otherwise, if you feel uncomfortable with the agreement’s provisions, you might have to walk away. There are plenty of other lenders that want your business.

If you decide that a personal guarantee is just too risky for your business, you have other options for obtaining financing. For example, you can get a business credit card with no personal guarantee.

You can also find some unsecured small business loans with no personal guarantee (or blanket lien).