When pursuing a small business loan, chances are your lender will ask you to provide a personal guarantee. But, if you’re a new business owner, you may have questions about the purpose of personal guarantees and how they work. Continue reading to learn about the most common types and how they might impact you and your business.
What is a Personal Guarantee?
A personal guarantee is an unsecured, written promise from the business owner pledging personal payment on the loan in the event the business itself would not be able to make payments. A personal guarantee might also be required from key company personnel – those without whom the business would not be able to operate.
Personal guarantees are often mistaken as collateral. Although the concepts are similar; lenders use both means as ways to lessen the risk, a personal guarantee is not directly tied to a specific asset of the owner(s) since it is unsecured.
Common Types of Personal Guarantees
- Unlimited Personal Guarantees: When you sign an unlimited personal guarantee, you agree to allow the lender to recover the entire loan amount (plus interest and legal fees) with personal assets if the company defaults on the loan. These items may include money from checking or savings accounts, college funds as well as other personal assets, such as your house or car. The creditor has the right to collect against the guarantee without attempting to collect against the company.
- Limited Personal Guarantees: Limited personal guarantees set a dollar limit on what can be collected from the borrower in the event the company defaults on the loan. This type of guarantee is often used when multiple business partners take out a loan for the company together. The Small Business Administration (SBA) currently requires that all loans are personally guaranteed by anyone with a 20% or greater ownership stake in the business. As with an unlimited personal guarantee, the creditor has the right to collect against the guarantee without attempting to collect against the company.
The purpose of a personal loan guarantee is to limit the risk of default lenders face by having borrowers put some “skin in the game.” Personal guarantees are relatively common in small business loans, so it’s important to have a solid understanding of how a guarantee could impact your own finances in the unfortunate event that the business doesn’t succeed.
Before you make a final decision about your business loan, be sure to consult with your business banker about all of your financing options. An honest conversation will help ensure you’re making the most practical decision for both your personal finances and the long-term success of your business.