Personal Guarantee: What is it? When Should You Use One?

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A personal guarantee is a written, legal promise that a borrower (typically the business owner) will repay business debts in the event that the business cannot. This means that if a business defaults on a loan, the business owner will be personally responsible for repaying the loan. Personal guarantees are normally unsecured, meaning there’s no specific collateral behind them. Instead, a lender will use the borrower’s personal assets to repay the debt.

Why Do Lenders Require a Personal Guarantee?

A personal guarantee is an extra form of “insurance” for the lender in the event that your business defaults on a loan. Personal guarantees will frequently be paired with collateral requirements to lower the bank’s risk in lending to you (small business loans are considered risky for banks due to the higher failure rates of small businesses). A personal guarantee also shows the lender that you are a responsible business owner committed to repaying your debts and willing to “put some skin in the game” for your own business.

Who Should Guarantee?

As a rule of thumb, it’s a good idea for all individuals who own at least 20% of the business to personally guarantee a loan. In fact, the Small Business Administration (SBA) now lists this as a requirement for the majority of its loan programs, and many banks and online lenders are following suit. Having more than one person guarantee the loan reduces the risk that a single person will have to fulfill the entire guarantee, which is good for both the lender and the borrowers.

Sometimes a bank may require a business owner’s spouse to co-sign a personal guarantee. If your personal and business finances are intermingled, then having a spouse co-sign can be appropriate. However, it’s still wise to talk to a lawyer about the consequences of having your spouse co-sign. Divorce or separation during the lifetime of the loan could have unintended effects on the loan contract. Moreover, if you are not part of the business’s executive or management team, you should never personally guarantee the loan.

How Much Should I Guarantee?

A personal guarantee doesn’t necessarily guarantee 100% of a loan, especially if a loan is backed by specific collateral. For instance, a lender may require a personal guarantee of 40% of the loan amount and use collateral to secure the remaining 60% of the loan. Lenders will have different requirements for how much a personal guarantee should cover, so there’s no ideal percentage that applies to everyone. However, many lenders are willing to negotiate a personal guarantee, and you’ll be in a better position to negotiate if you’ve demonstrated to your bank that you will successfully pay back the loan. This means having a sound business plan, good financials and strong team.

Personally guaranteeing a loan will involve risk to you as the borrower. As an entrepreneur, you should be okay with losing some money, but you shouldn’t risk personal financial ruin just to guarantee a business loan. You need to think about whether the loan is a worthwhile investment and if it is, what you can reasonably and comfortably guarantee. It may be helpful to speak with a financial advisor or certified public accountant who can help you identify whether you should be making this investment and for how much.

Other Considerations When Making a Personal Guarantee

One important factor to think about when personally guaranteeing a loan is the additional fees you may have to cover. If your business defaults on the loan, what are the extra charges that the bank may hold you responsible for? These charges could include accrued interest, legal fees, late payment fees or other costs. These costs will typically be stipulated in the guarantee agreement. This should go without saying, but you should read over your bank’s guarantee contract carefully. Better yet, have your lawyer or legal advisor look over the contract. They will be able to spot any red flags or risks that weren't apparent to you. The most important thing is to make sure you’re truly comfortable with the guarantee agreement before signing off.

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