Should You Commit to a Personal Guarantee for a Business Loan?
by Fundid on Mar 10, 2022 2:58:00 PM
Now that your business is thriving, you’re ready to fund your expansion project through a small business loan. But you’re surprised when your lender asks for a personal guarantee on business loans.
Before you sign any paperwork, it’s important to understand exactly what it means to provide a personal guarantee. Consider this your crash course in how these financial arrangements work and whether you’ll need to offer a personal guarantee when obtaining funding for your business.
What Is a Personal Guarantee on a Loan?
What is a personal guarantee? A personal guarantee is a legal promise to repay a loan issued to a business. In other words, by signing a personal guarantee, you are now personally liable for the loan or line of credit your business receives.
How Does Personal Guarantee on Business Loans Work?
If your company is new or has a poor credit history, your lender may ask for a personal guarantee before issuing a business loan or line of credit.
Applicants will provide details about their business, such as the employer identification number (EIN), but will also provide their Social Security number for a personal credit check and an inquiry regarding your financial history.
Small business owners might also pledge a portion of their income or assets as a form of collateral. For lenders, guaranteed personal loans mitigate financial risk since they are guaranteed to receive their money back, either from the business or the person who guaranteed the loan. As a borrower, providing a personal guarantee on business loans incentivizes success. Otherwise, the responsibility for repayment falls on you.
When Do Lenders Require a Personal Guarantee on Business Loans?
Personal guarantees are fairly common when applying for business loans. However, they are most beneficial when:
- Your business is new
- Your business hasn’t established business credit
- Your business credit score is low
In these circumstances, the lender will likely request a personal guarantee on business loans before approving your loan or line of credit request.
Types of Personal Guarantees
There are two broad types of personal guarantees: limited and unlimited.
Limited Personal Guarantee
A limited personal guarantee allows the lender to obtain only a certain percentage of the original loan from the business owner. This approach is commonly used when a loan is issued to multiple principals.
For example, if three people take out a loan, a limited personal guarantee would allow the lender to collect 33% of the loan balance from each principal.
Unlimited Personal Guarantee
By contrast, an unlimited personal guarantee enables lending institutions to collect the entire loan amount from the principal debtor.
Take note that all personal guarantees required by the U.S. Small Business Administration (SBA) are unlimited guarantees.
When Is It a Good Idea to Sign a Personally Guaranteed Business Loan?
As every entrepreneur knows, it’s not always easy to obtain funding that meets the needs of their business. Providing a personal guarantee on business loans can put much-needed financial resources within reach. It might be best to speak with a financial advisor about the best options based on your current books. Bench provides you with a personal accountant to help with these decisions.
Loans that Require a Personal Guarantee
A personal guarantee may be required anytime you apply for a large loan or when your business lacks a positive credit history. However, several types of loans will typically require a personal guarantee:
- SBA loans
- Short-term business loans
- Long-term business loans
It may be possible to find lending institutions that don’t require such arrangements for short or long-term loans. Not that these are the exception, not the rule. Business owners should be prepared to provide personal credit information to receive approval for their loan.
Pros and Cons of Personal Guarantees
There are several advantages of a personal guarantee:
- They provide funding to newer businesses
- They provide funding to companies with poor credit
- They protect lenders from unpaid loans
- They may provide better loan terms than other financing options
However, the obvious disadvantage of a personal guarantee is that you become personally liable for the debt.
Even if your business is structured to shield you from financial liability, offering a personal guarantee on a business loan will leave you on the hook for the loan amount, which could put your personal assets at risk if your business should fail.
Can a Personal Guarantee Hurt Your Credit Score?
Under ordinary circumstances, guaranteed personal loans will have no impact on your credit score. But like any loan or line of credit, your personal credit can be negatively affected if you miss payment deadlines or default on the loan.
Once the damage is done, it will likely show up on your credit report for seven years. Not only does this impact your personal credit, but it can prevent you from being approved for any future business loans. It’s good for you and your business to repay the loan promptly.
What to Do Before You Sign a Personal Guarantee for a Business Loan
By now, you’ve likely resolved yourself to the fact that you’ll need to offer a personal guarantee to obtain a business loan. But there are still some questions you should ask before you do. These questions include:
- Can you mitigate your personal risk with a limited personal guarantee?
- Will a personal guarantee help you find more favorable loan terms?
- Will the lender reduce the guarantee as your business grows?
- Can you exclude certain personal assets from being touched by the guarantee?
- Would the lender consider a smaller guarantee if you paid a higher interest rate?
These questions can be directed at potential lenders and may even help you find a lender that offers guaranteed personal loans with terms and conditions that are more favorable to you. Plus, these questions can help you sidestep loans that might put you and your family in jeopardy.
Additionally, you might consider obtaining personal guarantee insurance. What is a personal guarantee insurance policy? This type of insurance will protect your personal assets if you need to repay the business loan from your personal funds.
Are There Business Loans that Don’t Require a Personal Guarantee?
There’s no rule that you’ll always have to provide a personal guarantee to fund your business. For example, nonrecourse loans do not require a personal guarantee, though most banks do not even offer loans of this type, and those that do protect themselves with high-interest rates.
You might also consider invoice factoring or merchant cash advances, which use your future revenue as collateral for the money you receive today.
Similarly, equipment financing will allow you to fund the purchase or lease of specialized equipment without having to provide the kind of personal guarantee associated with a traditional loan.
Some entrepreneurs should consider grants to fund their next business venture. With this strategy, you find the funding that matches your business or industry and can finance your dreams without having to put your personal assets on the line.
Finance Your Future
In the business world, the right financing makes all of the difference. With the right amount of working capital, you can watch your next big idea take shape and impact your business and clients for years to come.
Need funding to grow your business? Fundid is re-imagining how businesses get the funding they need to grow. Explore your options through Fundid Capital.