A personal guarantee is a signed agreement between lender and borrower where the borrower agrees to be personally responsible for the loan should their business default. Lenders seek this type of guarantee when an entrepreneur is applying for a business loan.
Typically, when a small business loan goes into default, the assets of the business are on the hook. With a personal guarantee, you agree to put your personal assets up as well.
Will a personal guarantee increase my chances of getting financed?
Yes. A personal guarantee makes the loan a safer bet for the financier because they know they have other options outside your business assets should you default on the loan. Not only does a personal guarantee increase your chances of getting a loan, but it may also get you better loan terms like a lower interest rate.
Bad business credit? A personal guarantee can help
Businesses that apply for loans are often in varying states of stability and growth. Growing businesses that haven’t had time to build credit may have a hard time getting a business loan without a personal guarantee. It would simply be too risky for the banks to finance such a loan.
But many business owners have several valuable personal assets and a decent personal credit score, so they can sign a personal agreement to decrease the risk of the lender and increase their chance of getting a loan.
Even if your personal credit isn’t doing too hot, a personal guarantee may still be able to get you the financing you need. If not, there are other loan options for businesses with bad credit.
How does a personal guarantee affect the application process?
Because you’ll be leveraging your personal assets for better loan terms, your lender will want to run a personal credit check on you. Sometimes they’ll require you to include your credit history in the application itself instead of just authorizing a credit pull.
Since every lender collects different sets of information to approve a personal guarantee, you should ask up front about their process and what you’ll need to provide.
What are the risks of signing a personal guarantee?
As you may have guessed, the most severe risk in signing a personal guarantee is that you may lose your personal assets in the event of a default. The bank will have the right to seize your house, car, TV, and any other asset required for them to make up the remaining balance of the business loan.
Don’t sign a personal agreement for a business loan unless you’re highly confident your investment of the funds will yield enough profits to pay off the loan. Refine your investment strategy until it can’t fail.
Avoid using a personally guaranteed business loan to invest in material improvements that barely affect your bottom line. Items like fancy office chairs or a lifetime supply of office pretzels may bring increased comfort and endless salty goodness, but they won’t benefit your revenue stream.
What’s the difference between a limited and unlimited personal guarantee?
Limited guarantee. A limited personal guarantee specifies the amount of money a financial institution may legally collect on. This type of guarantee is common among partners who take out a business loan together—each party shares equal or unequal personal responsibility in paying back the loan, depending on the terms.
Unlimited guarantee. This kind of guarantee allows the bank to collect on the entire loan amount, including interest and any legal fees incurred in trying to collect on the loan. As with any personal guarantee, the bank can take from any of your personal assets, including your child’s college tuition fund.
What are some alternatives to a personal guarantee?
The fundamental reasons any business owner would sign a personal guarantee are to have a better chance of securing a business loan and getting better loan terms. There are a few other ways to accomplish these ends that don’t involve leveraging all your personal assets.
When you back a business loan with collateral, you get to choose what the bank can take in the event you default on your loan. With a personal guarantee, a bank can take your house, car, whatever they decide to go after. With a collateral-backed loan, a bank can only seize the specific asset or assets you put on the form.
So if you don’t want to be at risk of losing your home, you could put up your car instead. The bank will decide if you have enough collateral, but at the very least, you’ll get to choose the collateral to put up. Collateral-backed loans are safer for the bank in much the same way a personally guaranteed loan is, so you can expect a higher chance of getting funded and better loan terms.
Solid credit history and substantial company assets
If you’ve already built up a business with solid credit, promising growth, and valuable assets, you may be able to avoid a personal guarantee altogether. Your business assets may still be at risk in the event of a default, but at least your personal assets will stay safe.
Angel investors and venture capitalists generally fund these kinds of loans. With an equity loan, you don’t have to put any assets on the line. Instead, you’ll get an agreed-upon sum of money in exchange for offering your investor a percentage of equity ownership in your company and a portion of your profits.
This type of business financing relationship is difficult to acquire and will often cause you to lose some level of ownership and influence over your company, but it protects your personal assets if things go poorly.
Specific asset-backed loan
Sometimes you’re just trying to finance a new piece of equipment or afford brick-and-mortar real estate. In these types of purchases, you can usually back the loan with the equipment or real estate itself. If you default, you only lose the financed equipment or property. If all you need is some new equipment, it’s worth looking into equipment loans.
A personal guarantee is a great way to obtain financing and improve your business loan terms, but it’s not without its risks. A personal guarantee gives your lender free reign over which assets they choose to seize in the event of a default.
If your business investment plan is solid, you’ll be able to confidently accept a loan with a personal guarantee. That said, there are other kinds of financing available to you that don’t require you to put all your personal assets at risk.
For a roundup of some of our favorite loans that don’t require any collateral or guarantees, check out The 5 Best Unsecured Business Loans.