Getting approved for a small business loan if your company is relatively new or faces financial instability can be challenging. One way lenders offset their risk is by asking for a personal guarantee (sometimes spelled guaranty).
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A personal guarantee is a provision in your loan contract. When you agree to it, you’re taking personal responsibility for the loan if the business defaults and can’t repay it. In other words, if your business goes under or gets behind on loan payments, you are required to use personal assets to satisfy the debt.
Small business lenders commonly request personal guarantees.
Key takeways
Personal guarantees require an individual to take responsibility for the debt if a business defaults
Personal guarantees can be limited or unlimited
You may be able to avoid personal guarantees with other collateral
What is a personal guarantee?
A personal guarantee is a legal promise. By signing a contract with this provision, you agree that you will be personally responsible for the business’s debts if the loan goes into default. SBA loans require personal guarantees, as do many loans from online and traditional lenders.
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Even if you have good credit and meet all business loan requirements, a lender will often want extra assurance that you can repay no matter what.
If your business falls behind on loan payments and the lender begins enforcing the personal guarantee clause, you may face financial consequences and end up in court.
Lenders expect you to cover expenses from your personal funds as promised. However, if you’re unable or refuse to do so, the lender can begin legal proceedings and receive a judgment.
The lender could seize your personal assets to cover the debt. In other words, the lender could come after your home, personal savings, investment assets and more to make sure they get repaid.
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While negotiating the loan, you can ask to exclude specific assets from the personal guarantee.
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Types of personal guarantee
Personal guarantees can be unlimited or limited. One represents more risk than the other. The type of guarantee you’re offered may depend on how many of your fellow business owners put their assets on the line.
Unlimited personal guarantees
An unlimited personal guarantee is one in which the individual is responsible for the entire business loan and then some.
On top of being responsible for the full balance of the business loan principal, you could be on the hook for the lender’s legal fees and any outstanding loan interest or late fees.
If you’re the sole owner of your business, this might be your only option.
Limited personal guarantees
When you have a limited personal guarantee in your contract, there is a ceiling on how much of the business loan you are personally responsible for. This type of clause is often used when multiple business owners share the personal guarantee burden.
For instance, if you own 25 percent of the business, the contract may hold you personally liable for 25 percent of the business loan.
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With limited personal guarantees, a several guarantee means you are only responsible for a predetermined portion of the loan. But a joint and several guarantee means that if your business partners can’t fulfill their debt, your assets may be levied to cover their obligations, up to the total loan amount.
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Continuing guarantees
Both limited and unlimited personal guarantees for business loans can be continuing guarantees. A continuing guarantee extends the guarantee for your current business loan to all previous and future financial agreements with the same lender.
Even if you don’t sign a separate personal guarantee for a new loan agreement you enter with the same lender a year from now, the continuing guarantee will still apply.
How common are personal guarantees on business loans?
Personal guarantees are quite common on business loans from banks, credit unions and online lenders. According to a Small Business Credit Survey conducted by the Federal Reserve, 59 percent of small businesses used a personal guarantee to secure their funding.
As you browse loans, note that even some loans lenders label as unsecured still require a personal guarantee.
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Personal guarantee alternatives
You can sometimes use other types of collateral to secure funding. For instance, you may promise business assets or a portion of future sales.
If you’re taking out funding for a major piece of equipment like a semi-truck, the asset is typically the collateral. The lender will take it back if your equipment loan goes into default.
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Should I sign a personal guarantee?
Assess the level of risk you’re assuming before signing a personal guarantee. Are you taking on an unlimited guarantee, or will business partners help share the burden? Is the loan amount so great that you’d have to liquidate your home to repay it?
A personal guarantee may be a safe bet in a thriving industry if you’re taking out a modest loan or sharing it with other guarantors. It’s riskier on large loans where you’re the sole signatory. That said, being willing to sign a personal guarantee can be the difference between being approved or denied for a business loan.
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Does legalese make your heads spin? Have a legal expert review your loan contract and explain exactly what your personal guarantee means before signing it.
