Personal Guarantees, What They Are & Why They’re Needed

Posted at 14:12h in Small Business Financing by Pretha Yasmin

When your company applies for a business loan or other financial products like a business line of credit or commercial leases, you as the owner might be asked to make a personal guarantee. This is common and happens more often to companies without a long history in business, a less than excellent business credit score, or those in high-risk industries like travel and hospitality. In other cases, it may be standard procedure for the specific financial institution.

The lender, landlord, or financing provider wants to know that you believe enough in your business that you’re willing to leverage your own finances, just like they are.

In this article, you’ll first learn what a personal guarantee is and why it is required. After, we’ll go into what you may be able to negotiate on it, as well as some of the things you should be aware of like its potential impact on your personal credit score.

What Personal Guarantees Are

A personal guarantee is a legally binding agreement where a business owner or the joint owners in a business are required to allow a lender or financing provider to seize their personal assets if the business defaults on a business loan, their commercial lease, or a vendor agreement.

Personal assets can include:

Personal checking, saving, and retirement accounts

The owners’ houses (primary residences, vacation homes, and investment properties)

Investments like stocks, bonds, and other assets

Vehicles

Anything else of value that is agreed upon or not clearly defined as being protected in the agreement

Pro-tip: Before signing a personal guarantee, have your lawyer add clauses to exclude specific assets like retirement accounts or joint accounts, if you have a spouse, as a way to protect yourself. Not all lenders will allow this, but it does not hurt to try.

There are two types of personal guarantees that borrowers can make including limited (which has two sub-types) and unlimited.

Limited personal guarantees are where the borrowers are only responsible for a specific percentage of the amount owed on the debt. The two subtypes of limited personal guarantees are:

Several guarantees, where each signer is responsible for a specific share of the debt in a default situation.

Joint several guarantees, which is a situation where if one of the borrowers defaults, the other borrower must cover their business partner’s portion.

Unlimited personal guarantees are where the borrowers have agreed to cover the full cost of the loan from personal assets, and the lender will continue to seize and sell assets until their losses are covered.

Note: If a business defaults on the loan and the personal guarantee is enacted, this can be reported as a debt to the personal credit bureaus and may impact the owner’s personal credit scores negatively.

Why Personal Guarantees Are Required

Personal guarantees are required by the lender, landlord, or vendor to protect their assets if the company borrowing defaults on payments. It also builds confidence for the lender to know that the business owner or owners feel confident enough in their company that they’re willing to risk their own personal assets just like the lender, landlord, or vendor is risking their assets by lending.

There are situations where assets are limited, like two companies with equal business credit scores, financial histories, and creditworthiness want the same office space. The landlord can only lease to one of the companies, and if one is willing to make a personal guarantee, the landlord will likely choose them because their risk is lower with that company as a tenant.

This applies to large banks and alternative lenders giving small business loans. If there is a limit to how many loans they can provide because of the market, you need every advantage you can get to stand out. Personal guarantees are confidence builders that can help give you an advantage over other business owners who are applying and are not willing to make one.

Your Spouse or the Joint Owners’ Spouses May Be Required to Sign

One important thing to know before committing to a personal guarantee is that some states will require a spouse’s signature when the assets being placed in the guarantee are jointly owned. These are called community property and may be governed by community property laws and impact assets owned by both spouses or that are acquired during the marriage.

Talk to your lawyer and find out if this applies to you before you go to the signing table, so that you do not have to delay your financing. It is always a good idea to make sure your spouse is aware of the situation before committing.

Ways to Negotiate Them Down

Many lenders are going to require a personal guarantee, even when your company has strong financial records and an excellent business credit score. This includes unsecured and no collateral business loans. Just because a personal guarantee is required, it does not mean you cannot negotiate to get the best solution for your needs.

The more creditworthy (financially appealing) you can make your company, the better chance you can negotiate certain terms or limits on the personal guarantee including:

Going from unlimited to a limited personal guarantee

Reducing the limit amount on the personal guarantee

To make your company more creditworthy or desirable to lend to, which can also increase your approval chances and financing options, you can:

Increase your business credit score before applying.

Put a larger deposit down on the loan.

Improve your debt to service coverage ratio.

Place more assets as collateral including ones that appreciate in value over time.

Share your business plans that include taking additional loans during growth cycles as a way to let the lender know this is a long-term relationship.

Share Letters of Intent (LOI) and other documents where potential customers have shown interest in using your service if you can expand, and how the financing will give you the ability to do this.

If you’re asked to make a personal guarantee on a loan, a commercial lease, or financial product, don’t panic. This is part of the process and very common.

QuickBridge does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.