If you’ve applied for a business loan or you’re considering doing so, your loan approval might require a personal guarantee.
Many business owners are surprised when they’re asked for this assurance, but it’s a common requirement for banks, alternative lenders, and other lending institutions.
What’s a personal guarantee, why are they required, and what do they mean for your business? You’ll find the answers here! Use the info below to get prepared when you’re applying for funding.
What’s a personal guarantee?
Simply put, a personal guarantee is your promise to repay a business loan if your business is ever unable to do so.
Typically, personal guarantors are owners of the business. However, key employees and non-owners can be required to give personal guarantees if the business wouldn’t be functional or operational without them.
SBA lenders and most banks require anyone who owns 20% or more of a business to sign a personal guarantee. This is an important consideration if you’re bringing on partners who might be unwilling to provide their guarantee. If your guarantors have a lower personal credit score that’s impacted by delinquencies, charge-offs or high debt balances, it can also make it more challening for your business to get approved for a loan.
Why do lenders require personal guarantees?
Lenders require personal guarantees to reduce their risk of loss when they’re making a small business loan. Small businesses generally have a greater chance of defaulting on their payments than larger corporations. If a small business defaults on its loan, it’s also not likely to have enough collateral to cover the amount it. All of this puts a lender at risk of losing all or some of its investment when a default happens.
By having access to a personal guarantee, the lender has another source to recover its investment. And, as a business owner, being willing to personally guarantee your business shows that you have a vested interest in its success.
The key takeaway is: the lower the “risk of loss” for a lender, the greater the odds of approval for your small business loan.
What are the different types of personal guarantees?
The two most common personal guarantees you’ll see for small business loans are unlimited and limited. Here’s what you should know about each type:
Unlimited: Personal guarantees can be unlimited, which means that each guarantor agrees that the lender has the right to recover up to the full amount outstanding on the loan, plus interest, fees and legal fees from any one of the guarantors.
Limited: A limited personal guarantee means that the guarantors have a limited responsibility to repay the loan. It could be limited to a certain dollar amount, percentage, or by collateral pledged by the guarantor (for example, a lien on your personal residence). You’ll see limited personal guarantees usually when there are multiple owners of a business and the majority owners have already provided unlimited personal guarantees. It can also be used if someone that doesn’t own the business is being asked to guarantee and has personal collateral that’s being pledged to secure a loan.
For example, let’s say that a business owner pledges his home that is co-owned with his spouse. His spouse would be required to sign on as a personal guarantor; however, their liability is limited to the pledged asset which, in this example, is the home. The spouse is not responsible for repayment of the remaining amount of the loan.
Questions to consider when you’re asked to provide a personal guarantee
It’s ok to ask questions if your lender is asking for a personal guarantee! After all, it’s important for you to have a good understanding of what you’re agreeing to before you sign anything. Here are a few questions to consider:
How likely is it that a lender may use my personal guarantee?
As long as you’re repaying your loan as agreed, your lender will not need to use your personal guarantee. As the business owner, you should understand your underlying business operations and have confidence that your business will generate enough cash flow, in good times and bad, to repay the loan on time each month. If you’re in danger of default, confirm if your business has any assets that your lender can look to for repayment. More importantly, get in touch with your lender if it seems like you won’t be able to make payments. You may be able to make temporary arrangements to avoid a default.
Can I be released from my personal guarantee if I’m not involved in the business anymore?
It depends. When deciding to fund a loan, your lender considers the personal guarantors. Your lender could release your personal guarantee if the risk of loss is the same or lower, taking into consideration the business’s performance and/or any new guarantors. However, the lender is not required to release your personal guarantee just because you are no longer involved in the business.
Does a personal guarantee appear as a liability on my personal credit report?
You should ask your lender if it will appear on your personal credit report. Generally, if your business loan is being repaid as agreed, there won’t be a claim on your report related to your guarantee. However, certain lenders choose to file this loan information with the credit rating agencies in compliance with their institution’s lending policy.
Talk with your lender and Pursuit if you need assistance
Personal guarantees on small business loans are common and are required by most lenders to approve a loan. The most important action you can take is to make sure your business maintains timely payments on its debts. If your business is having trouble making payments on a loan, speak with your lender immediately to let them know and share your plans to remedy the situation.
If you’re looking for a loan to support your business needs, talk to Pursuit! We’re a community small business lender that offers more than 15 different business loan programs to fit nearly any business need. We may be able to help you refinance loans, lower your monthly payments, and get on the road to small business success. Or you can apply for a Pursuit loan for working capital, commercial real estate, and so much more. Reach out to us today to learn how we can work together.