Should I Sign a Personal Guarantee?
Chances are, if you’ve accepted business financing from a bank, credit union, online lender, or another source, you’ve been asked to sign a personal guarantee. This agreement (sometimes also spelled “personal guaranty”) is basically a promise that you, the business owner, are responsible for repaying a business loan should your business become unable to.
Unfortunately, you’ll likely have to sign a personal guarantee to get business financing. That said, all personal guarantees are not equal. Know what to look for, what to stay away from, and what you have a say in, and you could save yourself and your business potential hardship down the line.
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What is a Personal Guarantee?
A personal guarantee is an agreement whereby, if a business is unable to finish repaying a loan, the guarantors are responsible for repaying the loan with their personal assets.
Traditionally, a personal guarantee is signed by anybody who owns at least 20% of the business. The agreement is also commonly signed by a loan cosigner and the spouses of all guarantors.
This type of agreement is commonly required when you borrow capital from a bank, credit union, or online lender, and also applies to many business credit cards.
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. Many lenders that advertise “unsecured loans” probably still require this agreement.
Optimistic sources will tell you lenders require a personal guarantee because they want to make sure you’re committed to your business; the theory is that if you put your personal assets on the line, you’re definitely in for the long haul. That’s all well and good, but there’s another reason as well. Your lender simply wants to do everything they can to ensure they’ll get their investment back.
But you need to protect yourself as well. Personal guarantees often give all the power to the lender, so don’t sign away your rights, willy-nilly, without giving proper weight to your decisions. In other words, don’t let your lender pull a Rumpelstiltskin. Losing your business and personal assets won’t hurt quite as bad as handing over your firstborn, but it will be excruciating nonetheless.
The good news is that there are different types of agreements, and some of them offer more protection for you and your business partners. Understand the differences, and you’ll have a better chance of avoiding a bad agreement.
Types of Personal Guarantees
Normally, personal guarantees are divided into two categories: unlimited and limited agreements. Here are the basics of each one:
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 judgement against you.
For example, if you still owe $40K on your loan and it costs the lender $8K in legal fees to get a judgement against you, you will owe $48K.
An unlimited guarantee is the only agreement available for a single-owner business. 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 upon the agreement.
Limited guarantees are used when multiple business partners are signing for a loan. There are two different types of limited guarantee: a several guarantee, and a joint and several guarantee.
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.
In a scenario with multiple business partners, a several guarantee is more desirable because each partner knows (and agrees to) how much they’ll be responsible for ahead of time.
What Happens if I Default?
So what happens if your business can no longer repay your loan? Obviously, nobody wants to default on a business loan. Sometimes, however, it’s unavoidable.
The answer to the above question varies depending upon your situation. How much money you still owe and how many valuable personal assets you own are important factors that lenders consider when they are deciding whether or not to attempt to enforce the agreement.
Personal guarantees are difficult to enforce, especially compared to specific assets that have been put up for collateral. Often, the only way your lender can regain any lost capital is to take you to court and get a judgement against you. The lender may not deem the cause worthwhile if you don’t have very much money outstanding or if they are unlikely to get their capital back.
Should the lender gain a judgement against you, they might be able to seize business assets (like cash reserves, accounts receivable, or equipment) or personal assets (like jewelry and cars), or garnish your wages.
In most states, even if a lender gets a judgement against you, they cannot go after your house or retirement accounts.
Be aware that, even if the lender decides against suing you, defaulting on a loan will most likely have an effect on your personal and business credit scores, and your past-due debt will be sent to collections. For a more thorough explanation of the default process, and how to avoid defaulting if at all possible, check out this article.
Should I Sign a Personal Guarantee?
Chances are, if you want a business loan, the answer is yes. Unfortunately, you are unlikely to find a lender that doesn’t require a personal guarantee. Those that don’t require the agreement for some reason often charge extremely 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 are feeling uncomfortable with the provisions of the agreement, you might have to walk away. There are plenty of other lenders that want your business.
Again, I strongly encourage merchants who are getting a loan to carefully read over the contract, and to seek legal advice if possible. You may not read the fine print before downloading a copy of iTunes, but you definitely should before getting a business loan.