By Veronica Baxter
Every small business must contend with the challenges of financing their business operations. Whether you’re just starting up or expanding, business loans are often a critical part of a small business’s success. But what if you are required to personally guarantee the loan? Should you?
Read on to learn about how a personal guarantee works and the potential consequences of personally guaranteeing a small business loan.
What is a personal guarantee of a business loan?
Simply put, a personal guarantee of a business loan is a promise from the owner of the business that he or she will pay the loan if the business does not. Here are some pros and cons:
Pros:
- Often it is the only way a startup can obtain capital.
- Lenders will offer better loan terms if there is a personal guarantee.
- There is insurance available for personal guarantors to insure against default by the business.
Cons:
- If the personal guarantee is secured by personal assets, the business’s failure to repay and then your subsequent failure to repay puts those assets at risk.
- If the personal guarantee is unsecured and the business defaults, the lender can still sue you to collect if you fail to repay, and can garnish wages, levy on bank accounts, and file liens on real property.
A personal guarantee must be in writing and signed by the guarantor or the guarantor’s agent in order to be enforceable. It can be unsecured, meaning it is not secured to any one asset such as equipment or real property, or can be secured by property you own.
Be aware that any asset you pledge as security for a personal guarantee may be sold to satisfy the loan if the business defaults. Also, be aware that the guarantee document may provide that the guarantor is responsible for payment on the loan if the business defaults, as well as payment of interest, legal fees, and other fees.
If you are not an owner or on the executive team of the small business applying for a loan, use caution if requested to sign a personal guarantee. You may not be in a position to know the business’s full financial picture and whether repayment is likely to occur. It is always a good idea to consult an attorney when considering providing a personal guarantee of a business loan.
When do lenders require a personal guarantee?
A lender will often require a personal guarantee of a business loan as added assurance that the business owner intends to repay the loan regardless of the success of the business. It is common practice for lenders to require that entrepreneurs who own more than 20% of the business personally guarantee the loan; this is also the requirement for obtaining an SBA-guaranteed loan.
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In small businesses owned by a single person or a family, business finances and personal finances are often intertwined, so it is logical for a lender to require personal guarantees of repayment. Often the spouse of a business owner will be required to offer a personal guarantee as well, for the same reasons.