A personal guarantee is a legal promise by an individual to repay a loan made to their business with their own personal assets if the business is unable to repay the debt. So if the business defaults on its loan payments, the lender has the right to seize the business owner's personal assets to recoup its losses.
If you are applying for a small business loan, you are probably full of optimism and perhaps a little anxious. But when reviewing your loan offer, you may find that it includes a personal guaranty.
A personal guarantee is a legal clause designed to protect the lender in a situation where the business cannot repay its debts. If you sign a personal guarantee as a business owner, you may be putting your own and your family's financial future at risk. So before you sign on the dotted line, make sure you know exactly what a personal guarantee is and what types of guarantees are most common in your business loan agreement.
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Why some business loans require personal guarantees
Generally, you don't apply for a business loan with the intention of not paying it back. However, the reality is that not all businesses are successful and therefore not all debts that businesses take on are repaid. Lenders know this, and that is why they have created personal guarantees.
A personal guarantee is a legal promise by an individual to repay a loan made to their business with their own personal assets if the business is unable to repay the debt. Business loans with personal guarantees are usually unsecured loans because they are not secured by assets of the business such as commercial real estate or inventory.
A personal guarantee is usually signed during the loan application or approval process. It is not uncommon for small business owners to use a personal guaranty because they are invested in the success of their business. Also, without such a guarantee, they may not qualify for a loan.
With a personal guarantee, a creditor has a legal claim on the guarantor's personal assets. This can include checking or savings accounts, cars, real estate, and other liquid assets. A small business owner who wants to guarantee a loan usually has to provide his own credit history and financial background as well as his company's credit information.
The advantage of a personal guarantee is that if the personal assets are high, the lender's risk is mitigated, resulting in more loans and better terms, such as z. B. lower interest rates, may lead. Well-established businesses with a long credit history may be able to obtain financing without a surety bond.
Types of personal guarantees
Now that we know what a personal guarantee is, let's look at the two types of personal guarantees: unlimited and limited guarantees.
Unlimited personal guarantees
When you sign an unlimited personal guaranty, you agree that the lender can recover 100% of the loan amount in question, as well as any legal fees associated with the loan, through any means at its disposal.
If your business fails or you default on your loan for any reason, your lender can hire lawyers to obtain a judgment in its favor and then access your savings, retirement, your children's college fund, your home, your car, and any other assets it can find to cover the full cost of the loan plus interest and legal fees.
For example, if you still have 50.Owe $ 000 and are unable to service the loan and your lender 5.Spending $000 in legal fees to get a verdict in his favor, you owe 55.000 dollars that can be lawfully taken from any part of your finances to pay off the loan.
These guarantees are called "unlimited" for a reason. They offer you, the borrower, little to no financial protection if your business is not as successful as planned.
Limited personal guarantees
Limited personal guarantees, on the other hand, place a dollar limit on the amount that can be collected from you, the borrower, if you default on your loan.
Limited guarantees are often used when several business partners jointly take out a loan for their company. SBA standards require that all persons with at least a 20% interest in the company participate in the guarantee process. These guarantees help establish each person's share of the debt mountain if the business defaults on a business loan.
However, limited guarantees are not without problems. Before agreeing with your business partners to sign a limited surety bond, check whether it is a directly enforceable bond or a joint and several bond.
In a directly enforceable guarantee, each party is liable for a certain percentage. You know from the beginning the maximum amount you could owe in the worst case, d. h. A fixed percentage of the credit, which usually corresponds to your stake in the company.
In a directly enforceable guarantee, on the other hand, each party is potentially liable for the entire amount of the debt. The lender cannot recover more than is owed to him, but he can demand up to the full amount from any of the parties listed in the guarantee. So, if your business fails and your business partner disappears or does not have enough personal assets to cover his part of the loan, your lender can claim from you both your share of the guarantee and the part that was not paid by your partners.
What to look for in a personal guarantee
The boundaries between limited and unlimited personal guarantees are not always very clear. If you're not familiar with legalese, it's worth hiring a professional who can explain in detail the implications of the guarantee before you sign it. If you don't, you could be on the hook for a lot more than you bargained for.
Suppose you own a sunglasses business and the business goes out of business. If you signed a personal guarantee, your lender could seize the business and all of the sunglasses inventory, and then require you to help them convert the inventory to cash. Depending on the terms of your personal guaranty, you may be expected to spend a pre-determined amount of time selling the remaining sunglasses to your contacts (competitors, wholesalers, etc.).) to sell those assets to cash on their behalf.
After losing your business, the last thing you want to do is spend your time selling the leftover glasses to the highest bidder without getting a dime for them. A licensed attorney can identify clauses like these and explain what they mean before you agree to anything. Your business attorney may even be able to rewrite certain clauses in the contract and negotiate more amicable guarantee terms with the lender.
Whether you have access to an attorney or not, watch out for these gray areas in a personal guarantee agreement and proceed with caution.
"Bad Boy" Guarantee
In an effort to protect the borrower from fraud and other "bad" acts, a clause (often referred to as a "bad boy" guarantee) can be included in a limited personal guarantee that allows its conversion to an unlimited guarantee. This is to ensure that borrowers behave ethically and legally, as it allows a lender to take action against a fraudulent borrower, among other things, without having to worry about the legal costs involved.
Vague wording
Personal guarantees, even supposedly limited guarantees, are often intentionally vague in their wording and may include provisions and requirements for you as the borrower that you wouldn't even dream of. Because of such provisions, it is important to read between the lines as best as you can before signing a personal guaranty.
Alternatives to a personal guarantee
A personal guarantee is just one way a lender can protect its investment. If you don't want to risk your personal assets, you have other options. Of course, no loan is truly unsecured, so you'll need to secure your loan in one of the following ways instead.
Blanket business lien
A blanket business lien is like a personal guaranty, but for your business' assets, not your personal assets. This is a common legal claim that is included in the fine print of almost all small business loans. When lenders file liens for unpaid debts, they can sell a business's assets to collect the money owed to them.
If a lender files a blanket lien, it can essentially bankrupt your business to recover the principal and interest on your loan. Keep in mind that most loans that include blanket business liens also require personal guarantees. If your business assets are insufficient to pay the debt, the lender can draw on your personal assets.
Collateral
If you can provide collateral, you may have the opportunity to obtain a secured loan. Collateral is a specific asset or set of assets that guarantee a small business loan. If a business fails to make regular payments on the loan, lenders can obtain a court order to seize that particular asset from the borrower and liquidate it to repay the loan. Secured loans are considered secured loans, as opposed to loans with personal guarantees or blanket business liens that are considered unsecured. In general, it is better to put up collateral for a loan if you are able to do so than to put all your personal and business assets at risk with a personal guarantee or lien. Traditional collateral includes real estate, inventory, cash and unpaid bills.
Are personal guarantees worth the risk?
As you review your business loan agreement, you may wonder if a personal guarantee is worth the risk. This is a question that only you and your business partners can answer, although you may want to consult your business attorney and your accountant as well. However, there are some questions you can ask yourself to determine if a personal guarantee is worth it. The first of these is to have a plan in place to ensure you can repay your loan on time and in full? Of course, a business can experience the unexpected and have a few bad months or even go under, but you should still have a plan in place to help keep your business going long enough to pay off your loan.
Second, you should ask yourself if you have read through the details of your loan and the terms of the guarantee. We advise you to consult a lawyer to help you interpret the contract so that you don't have any surprises later on. If you have read through the contract with your attorney and you both conclude that it is fair and you have a plan to repay the loan, a personal guaranty may be a viable option for your business.
Finally, see if you can negotiate at all before accepting financing with a personal guarantee. You may be able to exclude certain family assets if you don't want to put certain things at risk. Another option is to ask if you can lower the guarantee to less than 100%.
The bottom line
Before agreeing to a personal guarantee, you need to look objectively at your business and finances and be aware of the real possibility that your business could fail despite your best efforts and intentions. Think about how each provision of the agreement might affect your business and personal finances. Ultimately, you need to ask yourself if the risk is worth the reward.
As a rule, you will repay all of your company's debts on time and in full, and you won't have to worry about your personal assets coming into play. In the event that something unexpected happens, you should still have a contingency plan to ensure your loan is repaid. If this is not the case, you should pause your loan search until your finances stabilize – this way you will not put your business or personal assets at risk.