Everything You Need to Know About Personal Guarantees
A loan can be challenging to obtain if your business lacks credit history. When this is the case, a lender may look to your personal assets to secure the loan. In fact, many lenders will require you to sign a personal guarantee if your business lacks a reliable track record of borrowing and paying back debt.
Still, while it may increase your chances of getting a loan, you shouldn’t rush into signing a personal guarantee without first understanding what this entails.
5 Questions About Personal Guarantees You Should Be Able to Answer:
1. What’s a Personal Guarantee?
A personal guarantee is a written promise that you’ll repay a loan with your personal assets if your business can’t make its debt payments. It can be secured or unsecured, meaning the lender may or may not require you to pledge specific assets as part of the guarantee. However, in most cases the lender can come after your home, investment accounts, or other personal assets if your business defaults.
2. Why Do Lenders Require a Personal Guarantee?
Lenders need a way to assess your ability to pay back a loan, and most small businesses lack the necessary credit history. Surprisingly, a recent survey by Manta found that 72 percent of small business owners don’t even know their business credit score. To overcome this obstacle, many lenders will consider your personal credit score as a proxy for your business’s creditworthiness.
3. What are the Advantages of a Personal Guarantee?
The main advantage of signing a personal guarantee is that it can increase your chances of being approved for a business loan, especially if your personal credit history is strong. It also signals to the bank that you’re willing to put your personal assets on the line for your business.
Small business loans can be risky for lenders, since more than 20 percent of small businesses fail in the first year. Therefore, you should show that you and your partners are willing to put skin in the game so that potential lenders are encouraged to also take a risk on your business.
4. What are the Risks Associated with Personal Guarantees?
The primary risk of signing a personal guarantee is that if your business fails to make its debt payments, you’ll be responsible for paying back the loan with personal assets. Depending on the size of the loan, you could lose your house, personal savings, or any other assets you submitted as collateral. It’s important to never pledge more than you can reasonably afford to lose.
If you can’t fully repay the loan with your personal assets, the lender can take legal action against you personally. A negative judgement can damage your credit, making it difficult to borrow money in the future. According to Equifax, negative information generally stays on your credit report for seven years.
If you sign a joint and several agreement with business partners, you may also be responsible for their share of the debt if the business defaults. This agreement allows the lender to collect the loan balance from any or all parties based on who has sufficient funds. So, if your partners come up short, you might be responsible for repaying the full amount.
Finally, if you sell your business while a loan is outstanding, don’t forget to have your personal guarantee released. If you forget and the new business owner fails to make payments on the loan, you can still be held liable.
5. Who Should Sign a Personal Guarantee?
A common rule of thumb is that anyone who owns at least 20 percent of the equity of a business should personally guarantee its loans. If you’re the primary business owner, this means you’re responsible for signing the personal guarantee.
In addition, if you’re married, your spouse will also have to sign. Lenders require their signature so that you can’t transfer your joint assets to your spouse’s name, freeing yourself from all risk.
Conclusion: Should You Sign a Personal Guarantee?
Deciding whether to sign a personal guarantee comes down to confidence in your business and the personal assets you’re willing to put on the line. Ultimately, a personal guarantee may be the only way your business can get a loan. However, it’s critical to evaluate all potential risks and discuss plans with your family before signing anything.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.