Basics of a Personal Guarantee
Business loans are the most common financing option used by startups and small businesses. However, most lenders require personal guarantees.
In this article, we will go over the basics of a personal guarantee.
What is a Personal Guarantee?
A personal guarantee is a borrower’s legal promise to repay a loan issued to their business using their own personal assets if the business is unable to repay the loan. Lenders have the right to seize and sell off the borrower’s pledged personal assets (such as your home) to pay off the remaining loan amount. Even established businesses may still use personal guarantees to gain funding at a lower cost by risking their personal stakes.
Why Do Some Lenders Require a Personal Guarantee?
The reality is that not all businesses will succeed and therefore, not all debt that those businesses take on will be paid back. Lenders know this and that is why they created personal guarantees to minimize lending risk.
Under a personal guarantee, a creditor has a legal claim to the personal assets of the guarantor such as cars, real estate, and other liquid assets. A small business owner seeking to provide a guarantee for a loan will typically need to provide their personal credit history and financials.
From a small business owner’s standpoint, the benefit of a personal guarantee is that if you have a lot of personal assets, you can use them to mitigate the lender’s risk, which can lead to more credit and potentially lower rates.
A personal guarantee can increase the chances of securing business funding. Depending on the value of your personal assets, you may qualify for better terms and rates. Since startup owners often use personal capital to finance their new business nonetheless, a personal guarantee can provide access to additional capital.
SBA loans will also require a personal guarantee from anyone with an interest of 20% or more in the borrowing company.
Types of Personal Guarantee
There are two common types of personal guarantees – limited and unlimited.
Limited guarantees allow lenders to only collect up to a certain amount of money or a certain percentage from the borrower. Limited guarantees are often used when multiple business partners take out a loan for the company together.
There are a few types of limited personal guarantees: “several guarantee” and “joint and several guarantee”. A several guarantee entails each party having a predetermined percentage of liability.
A joint and several guarantee, however, differs in that each party is liable for the full amount of debt. Lenders cannot take more than what is owed, but if your partners are unable to pay their portion, then the lender can instead target your personal assets.
Unlimited guarantees mean that you are agreeing to allow the lender to recover the full loan amount plus any additional fees associated with the loan. If your company defaults on payments, the lender can seize your assets to pay off the remaining loan amount.
Personal guarantees required by the SBA are considered unlimited guarantees.
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