Last Updated December 16, 2024
For small businesses, getting a loan to secure funding isn’t always easy. In fact, 77% of small business owners are worried about limited access to credit affecting their ability to expand or achieve other goals.
In light of common lending challenges, many lenders are willing to offer a loan when the business owner provides a personal guarantee. In this guide, we’ll help you understand personal guarantees on a business loan, how they work, and what you should know when taking out a loan.
What Is a Personal Guarantee on a Business Loan?
In the most basic sense, a personal guarantee on a business loan is a provision or addendum included in a business loan agreement that requires the business owner to repay the loan using their personal assets if the business defaults and the loan cannot be repaid with business funds.
Personal guarantees on a business loan provide an additional safety net for lenders. It ensures that they will still get repaid even if the business fails. However, for the borrower (or borrowers), signing a personal guarantee creates added liability since they may end up needing to repay the loan using their own assets.
Despite the added liability, a personal guarantee is often worthwhile for small business owners. A personal guarantee can increase the likelihood of having a loan approved, giving access to funding the business might not have received otherwise. In addition, banks may offer better loan terms (such as lower interest rates or larger loan amounts) with a personal guarantee.
How Do Personal Guarantees on Loans Work?
When a lender such as a bank requires a personal guarantee on a business loan, this will be included as a provision or addendum in the lending agreement. Most lenders, including government, bank, and online lenders, have this requirement for different types of business lending products, including both term loans and lines of credit.
Types of Personal Guarantees
There are two main types of personal guarantees small business owners should be aware of—unlimited and limited personal guarantees.
Unlimited personal guarantees are when a single individual is personally responsible for the loan (typical of a small business with a single founder). With an unlimited personal guarantee, you are responsible for repaying the loan in full if your business is unable to.
Limited personal guarantees see the responsibility for repaying the loan split between multiple owners. These guarantees sometimes include joint or several liability, meaning the lender could demand payment from just one or some of the guarantors rather than all of them.
However, it is most common for the personal liability to be split evenly between each of the owners who personally guaranteed the loan.
Why Do Banks Want Personal Guarantees?
While personal guarantees come with a fair amount of risk, they are often worth it for small business owners who have a sound business plan and are confident in their ability to repay using business funds. Banks themselves are highly motivated to require personal guarantees for the following reasons:
Greater Incentive for Compliance
A personal guarantee creates added risk for borrowers, which gives them an added incentive to comply with the terms of the business loan agreement. To lenders, this makes it more likely that the business will prioritize its debt repayment and remain compliant with the full terms of the loan agreement.
When financial institutions lend funds to risky borrowers who may have a history of nonpayment or simply lack of business credit history, it’s especially sensible as to why they would require personal guarantees. They need some reassurance that the funds will be repaid.
altLINE Vice President and General Manager Jim Pendergast explains, “Remember, your financial provider is on your side and should have your best interests in mind. They want you to avoid defaulting on a loan as much as you do. They don’t want to deal with the complexities of customers who can’t repay.”
It’s critical to do your due diligence when it comes to researching funding partners. Ask around your network for suggestions, read lenders’ online reviews, and talk to their customer representatives to ensure you get a good feeling about moving forward.
Assurance of Repayment
Enforcing a personal guarantee helps ensure that the debt will be repaid, even if the business goes bankrupt and is unable to pay using its own assets. By requiring that the owner (or owners) repay the loan using their personal assets in these circumstances, the lender can have confidence that they will get the money they are owed.
It’s totally understandable why borrowers have a cautious mindset when it comes to signing a personal guarantee. However, if you’ve carefully analyzed your business’s finances and projected future finances to make sure you’re in a position to not have to worry about defaulting on the loan, you can feel at ease.
What Happens When You Default on a Personal Guarantee?
What happens if you can’t pay a personal guarantee? This is an important factor to consider before agreeing to any business loan that requires a personal guarantee. These guarantees are legally binding, and it is extremely unlikely that the lender would waive one.
Unsurprisingly, the biggest risk of a personal guarantee is the loss of personal assets or finances to pay off the loan. Depending on the nature of the loan terms and the size of the loan, this could represent a significant financial setback for you and your household.
Defaulting on the personal guarantee if you are unable to pay with your own funds or assets can be even more problematic. The lender could seek a court judgment to enforce the personal guarantee. Because the loan appears on your personal credit report after the business defaults, it will also damage your credit score, making it harder to get personal and business loans in the future.
Depending on the severity of the situation, you might even have to declare bankruptcy. As a result of declaring bankruptcy or legal action taken against you, you will likely face other consequences, such as having liens placed on your property or experiencing wage garnishment.
Considerations Before Signing a Personal Guarantee
Clearly understanding the potential risks and benefits of a personally guaranteed loan agreement is essential. As you consider a personal guarantee, be sure to consider the following factors:
Personal and Business Finances
Start by assessing your personal and business finances. Do the cash flow management, budget, and overall financial health of your business mean it will be able to cover the terms of the loan agreement? A stable business is less likely to invoke the personal guarantee. However, you should also consider how the guarantee could impact your personal finances in case your business can’t cover the loan repayment.
Personal Guarantee Terms and Alternatives
The terms of a personal guarantee may vary between lenders. Be sure you understand key elements of the personal guarantee contract language, such as the extent and duration of your personal liability, what conditions would be considered a default by the business, and so on. You may also wish to negotiate for other options, such as using business collateral instead of a personal guarantee.
Alternative Funding Solutions
Remember, you don’t have to rely on a traditional business loan that requires a personal guarantee to obtain funding for your business activities. For example, invoice factoring allows you to essentially get a cash advance by selling your unpaid invoices to a factoring company. This allows you to get the money you are owed quickly without going into debt. Some businesses use grants to obtain funding without the risks associated with a personal guarantee. And some companies may even use crowdfunding to launch a new product or platform. Be sure to consider which alternative solutions could work for your business.
In-Summary: Business Loan Personal Guarantees
Obtaining funding is one of the biggest small business challenges—but a personal guarantee can make it easier to get a loan when your business needs that extra financial help. By reducing the risk to the lender, banks and other lenders become more likely to lend to your business or give you favorable loan terms. While this can help you fund expansion and other business activities, you must also understand the risks that come with being held personally responsible for the debt if your business defaults on the loan.
By fully evaluating your unique financial picture and exploring other funding options that could work well for your business, you can decide whether the risk and reward of a business loan personal guarantee makes sense for you. Making informed financial decisions is key to the success of your business.
Personal Guarantee FAQs
Do all business loans require personal guarantees?
No, not all business loans require personal guarantees. A personal guarantee may not be required if the business offers sufficient collateral to cover the loan. Lenders are also less likely to require a personal guarantee based on the business’s financial documents or credit score.
Can a personal guarantee be enforceable for a business?
Yes, a personal guarantee is enforceable when it is included as part of the loan agreement in writing and signed with a third-party witness present. If the guarantor does not make the payment, they could be subjected to court judgments or have their assets seized.
Can I get out of a personal guarantee?
Personal guarantees remain binding except in the unlikely event that the lender waives the agreement. Filing for personal bankruptcy may limit the impact of a personal guarantee and other debt but is generally a last resort.
Does a personal guarantee affect credit?
A personal guarantee will not affect your credit unless your business defaults on the loan and you need to pay from your own funds. The loan would then appear as a debt on your credit report. Failure to pay the loan would harm your personal credit score.
Does a personal guarantee need to be witnessed?
Yes, a witness (such as a solicitor or other independent party not involved in the loan) must typically witness the personal guarantee. This makes it enforceable and legally binding.
Do SBA loans require a personal guarantee?
Yes. If you own 20% or more of a small business, you must provide an unlimited personal guarantee when applying for an SBA loan.
Michael McCareins is the Content Marketing Associate at altLINE, where he is dedicated to creating and managing optimal content for readers. Following a brief career in media relations, Michael has discovered a passion for content marketing through developing unique, informative content to help audiences better understand ideas and topics such as invoice factoring and A/R financing.
