If you’re applying or thinking of applying for a business loan, your loan approval might require a personal guarantee.
You may be surprised when if you’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 guide below to prepare when you apply 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 business owners. However, key employees and non-owners can be required to give personal guarantees if the business wouldn’t be functional or operational without them.
Personal guarantees are considered standard practice for small business loans. Small Business Administration (SBA) lenders and most banks require anyone who owns 20% or more of a business to sign a personal guarantee. This is important to consider if you’re bringing on partners who might not want to provide their guarantee or have a lower personal credit score because of delinquencies, charge-offs, or high debt balances, making it more challenging for your business to get approved.
Why do lenders require personal guarantees?
Lenders require personal guarantees to reduce their risk of loss when they make 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 unlikely to have enough collateral to cover the full amount. All of this puts a lender at risk of losing all or some of its outstanding loan balance if a default happens.
By having access to a personal guarantee, the lender has another source to recover the funds. 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.This is the most common type of personal guarantee you’ll see.
Limited: A limited personal guarantee means 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). Limited personal guarantees are much less common and usually occur when there are multiple owners of a business, and they have already provided unlimited personal guarantees.
What to consider when you’re asked to provide a personal guarantee
It’s ok to ask questions if your lender asks 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 will use your 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 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 you be released from your personal guarantee if you’re 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, considering the business’s performance or any new guarantors. However, the lender is not required to release your personal guarantee simply because you are no longer involved in the business.
Does a personal guarantee appear as a liability on your 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 may file this loan information with the credit rating agencies for their institution’s lending policy.
Pursuit can help
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 entrepreneurs in New York, New Jersey, Pennsylvania, Connecticut, Nevada, Illinois, and Washington to fit nearly any business need. We can 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.
