What Should You Know About Personal Guarantees?
Personal guarantees are meant to protect the lender. Similar to a co-sign, personal guarantors are individuals who sign on to a loan with a business, and if the business can’t pay back the loan, the guarantor is personally responsible. This means that a lender can require cash payment, or they can seize personal assets, depending on the type of guarantee. It’s a legal clause, and is a way to make sure the lender gets their money no matter what. A guarantor can be you, as a business owner and individual, or it can be someone else not directly associated with your business – this is called a co-signer.
Getting a loan is stressful, no doubt. Especially when you throw in all the clauses and jargon, it can be a complicated process. In this post, we’re going to break down what personal guarantees are, and what you should know about them.
Personal guarantees aren’t that uncommon, and some lenders require them. They’re also used for those with less-than-stellar credit or those who don’t bring in enough income or revenue to theoretically make the payments. You should be careful, though, if you’re asked to be a guarantor – it puts your personal finances at risk if the business you’re signing for defaults on their payments.
This would also mean it affects your personal credit score, so it’s important to make sure that the business you’re signing for – be it your own or your business partner’s – will be worth this personal risk. Because ultimately, it is a risk for you, and a form of risk management for a lender. It’s advised you consult with a legal professional before signing anything, but especially if a business loan includes a personal guarantee. There are several different forms and executions of personal guarantees, so it’s important to read between the lines.
The Lender’s Perspective
Lenders are running a business, too. From their point of view, they are trying to minimize their losses and maximize their returns. The only way for them to do that is to get their money back, and by making you sign a personal guarantee, this increases the chance they’ll get paid back. It’s like a back-up plan.
Limited Personal Guarantees
Limited personal guarantees have a set dollar amount on what can be charged to the borrower if they default on their loan. These are usually used when multiple business partners are personally guaranteeing a loan, and they define each individual’s piece of debt if the business fails to repay.
There are two types of limited personal guarantees you need to be aware of, and it’s advised you look over agreements carefully to distinguish which you’re dealing with.
- Several guarantee – each individual knows at the beginning of an agreement the maximum they might owe, represented as a percentage of the loan.
- Joint and several guarantee – this differs from a several guarantee in the sense that the percentages aren’t predetermined, and the lender can go after any individual guarantor to collect the full amount. This is especially dangerous because if your partner goes MIA after a business fails, you could be responsible for all repaying every penny.
Unlimited Personal Guarantees
Unlimited personal guarantees mean that you’re agreeing to let your lender recover all of the loan in addition to any other fees associated with the loan, such as legal fees should the lender have to take legal action against you.
Unlimited personal guarantees offer the borrower, and thus the guarantor, essentially no financial protection if the business in question fails.
The SBA actually requires personal guarantees for their loans, but they call them “unconditional guarantees.” They require that individuals who have at least 20% equity in a company have to provide a personal guarantor, and they provide a form that details the stipulations of their unconditional guarantee. The SBA also warns that selling your company doesn’t get rid of your guarantee, and recommends waiting to sell your interest until you’ve fulfilled your guarantee, or your loan is paid off.
Personal guarantees aren’t anything to be afraid of, but you should be aware of them. Like any loan, there will be risks, so it’s best to know about all your options. FaaSfunds can help with that – we’re here to show you the best loans for your financial needs, and to connect you with an advisor to help you make financing decisions. Sign up today.