Should You Sign a Personal Guarantee on a Business Loan?
E.J. Simonsen | Jan 10, 2023
Nearly all lenders hope to secure personal guarantees, even when unnecessary, and will therefore request one. You should push back on this request to shed light on the actual necessity of risking your personal name and assets. If they persist, ask exactly what is required to avoid a personal guarantee.
Lenders desire and sometimes require personal guarantees as a way to reduce their risk when lending money to small businesses or startups. By requiring a personal guarantee, lenders have an additional layer of protection in the event that the company is unable to pay. If your business lacks a solid business history, financials, or business assets which it can pledge as collateral, you may be required to sign a personal guarantee to secure financing, at least from that lender.
However easy that may seem, it may not be your best option. We’re here to help and explain whether or not you should sign a personal guarantee on a business loan and what are other options.
What Is a Personal Guarantee?
A personal guarantee is a legal agreement in which an individual (usually the business owner or principal) agrees to be personally responsible for repaying a debt, loan, or other obligation if the business cannot do so. By signing a personal guarantee, the individual puts their personal assets, such as their home, car, or savings, at potential unlimited risk if the business defaults. Essentially, the business owner as guarantor promises to repay the debt from their own wages, finances, property, etc, if the business is unable to do so.
Should You Sign a Personal Guarantee on a Business Loan?
First, as a general rule of thumb, you should never sign a personal guarantee, much less for a business loan if you can avoid it. That guarantee could put you at risk beyond simply personal bankruptcy if your business fails to meet its obligation. If the business defaults, commercial debt collectors are not required to abide by Federal Fair Debt Collection Act laws, which typically shield individuals from harassment.
You can expect creditors and their debt collectors to contact your family, a new place of work, social media, attack your personal bank account, and e-commerce apps such as Venmo, Facebook Marketplace, PayPal, Cash App, etc. Moreover, they will likely file suit and may allege you defrauded them which can survive even personal bankruptcy.
Here are some factors to consider when deciding whether or not to sign a personal guarantee on a business loan:
- Your personal financial situation: If you have a stable income and a solid credit history, you may be in a better position to sign a personal guarantee. If you have a lot of debt or a poor credit score, taking on additional personal liability may not be wise.
- The lender's requirements: Some lenders require a personal guarantee to get a loan. If this is the case, you may not have a choice.
- The size and purpose of the loan: If you're borrowing a small amount of money for a short-term project, the risk may be lower than if you're taking out a large loan to fund a long-term investment.
- Your level of confidence in your business's ability to repay the loan: If you believe your business is likely to generate enough revenue to repay the loan in the amount of time allotted, you may be more willing to sign a personal guarantee. Taking on personal liability may be too risky if you're not confident in your business's ability to generate revenue.
Ultimately, the decision to sign a personal guarantee on a business loan is a personal one that depends on your individual circumstances. It's important to carefully consider the risks and benefits before making a decision. If you’re unsure of the best decision, consulting with a financial adviser or attorney will be beneficial.
Are There Any Ways to Avoid Signing a Personal Guarantee on a Business Loan?
If you want to avoid signing a personal guarantee on a business loan, there are some things you can do. Whether or not this is an option for you depends on the lender you’re working with and your specific situation. But in general, here are some options you could consider:
- Offer collateral: One way to reduce the lender's risk and potentially avoid a personal guarantee is to offer collateral, such as real estate, equipment, or inventory, as security for the loan. If you default on the loan, the lender can seize the collateral to repay the debt.
- Improve your credit: If you have a strong credit history and a good relationship with the lender, you may be able to negotiate more favorable loan terms that don't require a personal guarantee.
- Consider alternative financing options: There are alternative financing options that don't require a personal guarantee, such as invoice financing, crowdfunding, or business lines of credit. These options may have higher interest rates or other fees but could be a viable option for businesses that want to avoid personal liability.
- Find a co-signer: You can find a co-signer, such as a business partner or family member, willing to sign a personal guarantee on your behalf. This can be risky for the co-signer, so make sure they understand the potential consequences before agreeing to do so.
Are There Types of Personal Guarantees That Are Safer Than Others?
The types of personal guarantees that lenders offer fall into two categories:
- A promise to perform
- A promise to pay
A Promise To Perform Personal Guarantee
A promise to perform a personal guarantee states that the individual (usually the business owner or principal) agrees to take specific actions to ensure that the business meets its obligations under the loan agreement. These actions could include things like making timely payments, providing financial statements, or maintaining certain levels of insurance. If the business fails to meet its obligations, the lender can hold the individual responsible for any resulting losses or damages.
By focusing on specific performance requirements, a promise to perform a personal guarantee can reduce the risk to the business owner while still providing the lender with some assurance that the business will meet its obligations.
A Promise To Pay Personal Guarantee
A promise to pay personal guarantee states that the individual (usually the business owner or principal) agrees to be personally responsible for repaying the loan if the business is unable to do so. The individual is risking their personal assets if the business defaults on the loan.
Within the promise to pay personal guarantees, there are two subtypes:
- Limited Personal Guarantees
- Unlimited Personal Guarantees
The main difference between the two is the extent of the personal liability the guarantor assumes in the event of a default.
A limited personal guarantee places a cap on the amount of personal liability that the guarantor assumes. The guarantor is only responsible for repaying a specific amount of the loan, typically up to the amount that was initially borrowed. Once that amount has been repaid, the guarantor is no longer responsible for any additional debt.
An unlimited personal guarantee does not place a cap on the amount of personal liability that the guarantor assumes. The guarantor is responsible for repaying the entire loan amount, including any interest or fees, if the business cannot.
As a rule of thumb, limited personal guarantees are the best option. There is a specified limit the business owner will be responsible for paying back, rather than an uncapped amount.
Struggling to Pay Back a Business Loan with a Personal Guarantee? We Can Help.
If your business is struggling to make ends meet, and you’re worried about how a personal guarantee might affect you, contact The Lane Law Firm. Our business debt relief attorneys can help you determine the best path forward and prevent your personal assets from being affected. Give our team a call today, or reach out on our website.