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What Is a Personal Guarantee on a Business Loan?

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Getting a business loan is one thing, but signing a personal guarantee for one is another. Find out how these two work in conjunction with each other.

June 6, 2024
Author: NCH

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Business loans are necessary for anyone looking to start or expand their operations. However, one significant aspect that often accompanies business loans is the requirement of a personal guarantee. Understanding how a personal guarantee works on a business loan and its associated risks may help borrowers down the line.

What Is a Personal Guarantee?

A personal guarantee is a legal commitment made by a business owner or executive to repay a business loan if the business fails to do so. Lenders often require this guarantee to mitigate the risk of lending to small or newly established businesses that may not have a solid credit history or sufficient collateral.

Types of Personal Guarantees

  • Unlimited Personal Guarantee: This guarantee holds the individual liable for the full loan amount. If the business defaults, the lender can pursue the guarantor’s personal assets, including their home, car, and personal bank accounts, to recover the debt.
  • Limited Personal Guarantee: In this scenario, the guarantor’s liability is capped at a specific amount or percentage of the loan. While this limits personal exposure, the guarantor’s personal assets are still partially at risk.

How Personal Guarantees Work

When a business loan is taken out, the lender assesses the risk of lending to the business. Lenders may perceive higher risk for newer businesses or those with less established credit histories. To mitigate this risk, they may require a personal guarantee and other requirements from the business owner or another individual involved with the company.

The Process of Providing a Personal Guarantee

  1. Assessment of Personal Financial Status: Lenders will review the personal financial status of the guarantor. Doing so includes credit scores, personal assets, liabilities, and financial health.
  2. Signing the Guarantee: The guarantor signs a legal document agreeing to the terms of the personal guarantee. This document outlines the extent of the guarantor’s liability and the conditions under which the guarantee can be invoked.
  3. Enforcement: If the business defaults on the loan, the lender can enforce the personal guarantee. This may involve legal action to seize the guarantor’s personal assets to cover the outstanding debt.

Risks Associated with Personal Guarantees

Financial Risk

The most direct risk is financial liability. If the business cannot meet its debt obligations, the guarantor must cover the outstanding debt. This can lead to substantial financial strain, potentially resulting in personal bankruptcy. The guarantor’s personal assets, including homes, savings, and other properties, may be at risk of seizure by creditors to satisfy the debt.

Credit Score Impact 

Defaulting on a personal guarantee can damage the guarantor’s credit score. The default will be recorded on the guarantor’s credit report, which can lead to higher interest rates on future loans, difficulty obtaining credit, and potentially higher insurance premiums. This impact on the credit score can persist for years, affecting personal and professional financial plans.

Limited Control Over Business Decisions 

Guarantors often have little control over how the borrower manages the loan or lease. Despite being liable for the debt, the guarantor might not be involved in the borrower’s business operations or financial decisions. This lack of control exacerbates the risk, as poor management or unforeseen business downturns can result in default.

Obtaining a Business Loan Without a Personal Guarantee

Although personal guarantees are common, they are not the only way to secure a business loan. Here are several strategies to get financing without putting personal assets at risk:

Build a Strong Business Credit Profile

One of the best ways to avoid a personal guarantee is to build a strong business credit profile. Lenders are more likely to offer unsecured loans to businesses with a proven track record of financial responsibility. Steps to build a strong business credit profile include:

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  • Registering your business with credit bureaus
  • Maintaining good relationships with suppliers and creditors
  • Making timely payments on business debts
  • Monitoring your business credit report regularly

Offer Collateral

Some lenders accept business assets as collateral instead of a personal guarantee. These could include equipment, inventory, accounts receivable, or real estate. Even though this still involves risk, it limits exposure to business assets rather than personal ones. By providing valuable collateral, the lender has a form of security against the loan.

Seek SBA Loans

Government-backed loans, such as those offered by the Small Business Administration (SBA), can be an excellent option. Despite requiring detailed applications and compliance with specific guidelines, SBA loans often come with more favorable terms and lower risk, as the government guarantees a portion of the loan, thereby reducing the need for a personal guarantee. 

Explore Alternative Financing Options

Traditional bank loans are not the only option for business financing. Other alternatives include:

  • Business Credit Cards: Many business credit cards do not require a personal guarantee, especially for established businesses with good credit.
  • Equipment Financing: If you need funds to purchase equipment, equipment financing can use the equipment as collateral, eliminating the need for a personal guarantee.
  • Invoice Financing: This involves selling your outstanding invoices to a factoring company in exchange for immediate cash, and it does not require a personal guarantee.
  • Crowdfunding: Platforms like Kickstarter and Indiegogo allow you to raise funds from the public without taking on debt or giving a personal guarantee.
  • Peer-to-Peer Lending: Peer-to-peer lending platforms connect you with individual investors who may offer more flexible terms than traditional lenders.
  • Grants and Competitions: Various organizations offer grants or host competitions that provide funding without repayment requirements.

The Bottomline

Ultimately, the goal is to balance the need for capital with the desire to protect personal assets, ensuring the business can grow and thrive without compromising financial security. While personal guarantees can facilitate access to business loans, they come with significant risks. Each business is unique, so evaluate all available options and consult financial experts to determine the best approach for securing financing.

Our mission at NCH is to help businesses secure the funding they need while protecting their personal assets. With more than 30 years of experience, we have established ourselves as trusted partners for businesses of all sizes.

Call 1-800-508-1729 or visit our website to schedule your free consultation!

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.

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