Personal Guarantee Basics
Business Loans and Personal Guarantees
When businesses borrow money, banks sometimes require a personal guarantee from the business owner (or other key individuals in the business). Ideally, the business would borrow on its own - without involving anybody's personal assets - but sometimes that's not an option.
A personal guarantee allows a business owner to borrow by putting his or her personal finances on the line (the individual's credit score and assets are at risk).
Personal Guarantee Basics
Lenders always evaluate borrowers to predict whether or not they'll repay. For consumer loans, there are credit scores and numerous other sources of information to help with the decision. However, businesses - especially new businesses and operations that have never borrowed - probably don't have a business-specific credit history.
With limited information it’s hard for lenders to make a decision. They would be more comfortable if they could see that you've borrowed money in the past and consistently repaid loans. When they can't make a decision based on historical information, they require some sort of security (or they charge an extremely high interest rate). That security often comes in the form of a personal guarantee, although other approaches such as pledging business assets as collateral, can be used.
With a personal guarantee, the business owners (or whoever else guaranteed the loan) sign an agreement saying they are personally responsible for repayment.
Even if the business is incorporated to limit personal liability, you are personally tied to any loan you've made a personal guarantee on.
Without a personal guarantee, many small businesses simply can’t get loans. Banks want to improve their chances of getting paid, and they know that businesses fail all the time.
Lenders want to have options: they want to be able to collect no matter what happens to your business. They may also wonder why they should take a risk if you as a business owner are not willing to put skin in the game.
What's the Risk?
When you provide a personal guarantee, you allow a lender to pursue you personally if you can’t repay a business loan. That can mean different things, depending on your loan agreement. As part of the guarantee, you might have given the bank permission to take assets such as property you own (including your home or certain valuables) or investment accounts.
It's also likely that lenders can take legal action against you, which would damage your credit and make it difficult to borrow in the future (not to mention potential hurdles for getting a job, buying insurances, or renting a place to live).
Family assets: your personal guarantee for the business loan may affect your family. Losing the house is obviously a problem. Some loans may also require your spouse’s guarantee so assets held solely in your spouse’s name are fair game as well (otherwise, you might be tempted to transfer assets to your spouse's name).
Paying for partners: you may be on the hook for more than your fair share if you see the term 'joint and several.' This allows the bank to try to collect the entire balance from any and/or all partners who personally guaranteed business loans.
If other partners can’t pay, the bank may demand the entire balance from you: eEven if you aren't a 100% owner, you might be 100% responsible for the debt.
Manage the risks: over time, you’ll want to move away from personal guarantee business loans. Once you build credit for your business and gather assets for collateral, you can stop guaranteeing loans.
- Learn more: Business Credit Basics
In the meantime, minimize the risk by borrowing wisely: When You Can’t Get Business Credit Without Personal Guarantees.