However, it can be immensely challenging to get approved for a term loan if your business lacks credit history. If this is the case, a business lender may look to your personal assets to secure the loan. Many financial institutions 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 approved for a loan, you shouldn’t rush into signing a personal guarantee without first understanding it.
In this blog post, we’ll explain how you can secure an unsecured business loan and why signing a personal guarantee may be a viable option if this isn’t possible.
What You Should Know About Personal Guarantees On Business Loans:
1. What’s a Personal Guarantee?
A personal guarantee is a written promise to repay a business 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, the lender can come after your personal finances, real estate, 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 many small businesses lack the necessary credit history. Surprisingly, a survey by Manta found that 72 percent
of small business owners don’t even know their business credit score. Many business lenders will consider your personal credit score as a proxy for your business’s creditworthiness to overcome this obstacle.
3. What Are the Advantages of a Personal Guarantee?
The main advantage of signing a personal guarantee is increasing your chances of being approved for a business loan. It also signals to the bank or lender that you’re willing to put your personal assets on the line for your business.
Providing business funding with no personal guarantees 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 business 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, expensive equipment, or any other assets you submitted as collateral. It’s essential never to 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. A negative judgment 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 liability agreements
with business partners, you may also be responsible for their share of the debt if the business defaults. This agreement allows the business 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 total loan amount.
Finally, if you sell your business while a loan balance 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 balance, 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, you’re responsible for signing the personal guarantee.
In addition, if you’re married, your spouse will also have to sign the personal guarantee. 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 to Secure a Business Loan?
Deciding 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, signing a personal guarantee may be the only way your business can get approved for a loan or a business line of credit. However, it’s critical to evaluate all potential risks and discuss plans with your family or business partner before signing anything.
Editor’s Note: This post was updated for accuracy and comprehensiveness in May 2022.