If you’ve applied for a business loan or are considering doing so, there’s a requirement that most lenders have and it often comes as a surprise to borrowers: it’s the personal guarantee.
In this article, we look at what lenders mean by personal guarantee, why it’s required and what they include.
What is a personal guarantee?
Simply put, a personal guarantee is a business owner’s promise to repay a business loan personally, in case the business is ever unable to do so.
Though most lenders require a personal guarantee, they will only invoke it as a last resort to minimize losses. In fact, reputable lenders will only pursue this option when a business defaults on a loan – meaning that multiple payments are missed or the business otherwise doesn’t meet the terms of the loan.
It may also be invoked if the business’s assets aren’t sufficient to cover the outstanding balance. Default could be cause by cash-flow shortfalls that result in missed payments or more dire circumstances, such as when a business owner suddenly closes the business.
Why do lenders require personal guarantees?
Lenders request or require personal guarantees to reduce the risks associated with making small business loans.
Typically, all owners who have a stake of 20 percent or more in a business are required to sign a personal guarantee. Guarantors may also include friends or relatives who agree to personally guarantee a loan. For SBA loans, key employees may be required to sign personal guarantees if the business wouldn’t be functional or operational without them, even if they don’t own a stake.
Payment recovery may include both monetary and personal assets. There are two types of personal guarantees:
Unlimited: Personal guarantees can be unlimited, meaning that all guarantors agree that the lender has the right to recover the full amount outstanding on the loan, plus interest, fees and legal fees. With an unlimited personal guarantee, lenders can take money from your savings, retirement, college fund, etc.
Limited: Personal guarantees can be limited, meaning that guarantors’ responsibilities are restricted to assets they’ve pledged. In other words, there’s a set dollar limit which the lender can collect from the borrower if they default on their loan. This is a common type of guarantee for businesses with multiple partners and guarantors because it ensures that each individual has a defined piece of debt should the company go under.
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.
What can personal guarantees include?
If a business is unable to repay its business debts, a lender will first claim business assets (if there are any of value), then seek repayment from the business owner personally. Personal assets can include homes, cars, boats, recreational vehicles, monetary assets like funds in checking and savings accounts and anything else that can cover the lender’s potential losses. For a borrower’s personal assets to be considered collectable, a personal guarantee must include them at the time that the loan was closed.
Talk with your lender and Pursuit if you need assistance
Personal guarantees on small business loans are common and expected, as are timely payments on debts. If you find that you’re having trouble making payments on a loan, speak with your lender immediately – most prefer to work out a solution, rather than seize assets.
Additionally, contact Pursuit. We’re a community-focused lender that’s helped thousands of small businesses obtain loans that are affordable. We may be able to help you refinance loans, lower your monthly payments and get back on the road to small business success.