September 5th 2023.
Personal guarantees are a legally binding agreement that provides security to lenders in the case of a loan default. It allows them to pursue the business owner’s personal assets if the company cannot repay the loan. This protection circumvents the limited liability protections of many businesses, putting the personal assets of the business owner at risk.
Lenders often require a personal guarantee for small business loans, especially from partners with a 20% or greater ownership stake. Even when optional, signing one can often lower the interest rate on the loan. Banks, credit unions, online lenders, and government lenders are some of the financial institutions that require a guarantee.
Personal guarantees are usually included when you apply for a loan, and you’ll have to sign them during the closing process. If the business defaults on the loan, lenders will pursue the money from the business assets and then, if necessary, the business owner’s personal assets. In some cases, the lender might sue for any remaining amounts.
Lenders require a personal guarantee to offset credit risk and to provide security for unsecured business loans. It’s also a requirement for some government-backed business loans, such as SBA and USDA loans.
The benefits of a personal guarantee are that it could help you get approved for the best unsecured business loans and unsecured financing. However, it also significantly increases your risk when taking out a business loan. If you default on the loan, it could damage your personal credit score and ability to borrow in the future.
To avoid a personal guarantee, you should try to improve your credit profile, annual revenue, and business history. Negotiating with the lender and shopping around for the best offer can also help.
The types of business funding that have the best chance of not requiring a personal guarantee are secured business loans, but they still might require a PG.
What is a Personal Guarantee for Business Loans?
A personal guarantee is an agreement that a business owner signs to pledge to repay a business loan. In the event of a loan default, this allows lenders to pursue the business owner's personal assets. As such, it provides more security for the lender, but less protection for the individual.
Many businesses have limited liability, which provides some insulation for business owners from issues affecting the business. However, a personal guarantee circumvents these limited liability protections, meaning that a business owner's personal assets are at risk in the event of a loan default. This is why many lenders require business partners with a 20% or greater ownership stake to sign a personal guarantee before approving a loan. In some cases, this can even result in a lower interest rate on the loan.
Financial institutions that require a personal guarantee for small business loans include banks and credit unions, online lenders, and government lenders. Lenders usually ask for a personal guarantee when you apply for a loan, and it is one of the documents you sign during the closing process.
If a business defaults on the loan, lenders first pursue business collateral. If there is a remaining balance after foreclosing on business assets, lenders might then pursue money from the business owner's personal assets. In addition, if the debt is not paid, the lender could sue for the remaining amount, which could result in garnishing of wages, going after personal property, or money in the accounts of the business owner.
There are two main types of personal guarantees - unlimited and limited. An unlimited personal guarantee means the lender can pursue the full amount owed, while a limited personal guarantee sets a cap on how much the lender can pursue in the case of a default.
Why do Lenders Require a Personal Guarantee?
There are several reasons why a lender might require a personal guarantee. It could be that the loan is an unsecured business loan, meaning that there is no collateral. In this case, the guarantee provides extra security for the lender. Another reason could be that the lender wants to offset credit risk, and so requires the guarantee in order to do so. Finally, some government-backed business loans also require a personal guarantee.
What are the Benefits and Drawbacks of a Personal Guarantee?
A personal guarantee can help you get approved for the best unsecured business loans. However, it does significantly increase individual risk when taking out a business loan. If the business defaults on the loan, it could impact the credit score and ability to borrow in the future of the owner.
How Can I Avoid a Business Loan Personal Guarantee?
There’s no surefire way to avoid a PG. However, improving your credit profile and making sure that you have high revenue, strong cash flow, and a proven success track record could help you avoid the requirement. Negotiating with the lender and shopping around could also help.
What Business Loans don’t require a Personal Guarantee?
Unfortunately, there’s no definitive business loan category that doesn’t require a PG. However, secured business loans are more likely to not require a personal guarantee. Additionally, there are some lenders who don't require a guarantee, which is why it is always a good idea to shop around and compare loan offers.
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