A personal guarantee is a legal promise made by an individual to repay credit issued to their business using their own personal assets in the event that the business is unable to repay the debt. Therefore, if the business defaults on its loan payments, the lender has the right to seize the business owner’s personal assets to recoup their losses.
If you’re applying for a small business loan, you’re likely full of optimism and maybe a little anxiety. But in the process of examining your loan offer, you might see that it includes a personal guarantee.
A personal guarantee is a legal clause designed to protect the lender in a situation where the business is unable to pay back its debt. If you as a business owner sign a personal guarantee, you could be putting you and your family’s financial future at risk. So before you sign that dotted line, make sure you completely understand what a personal guarantee is, as well as the most common types of guarantees you might encounter in your business loan agreement.
Generally, people don’t apply for a business loan with the intention of not paying it back. But the reality is that not all businesses succeed and, therefore, not all debt that businesses take on is paid back. Lenders know this, which is why they created personal guarantees.
A personal guarantee is a legal promise made by an individual to repay credit issued to their business using their own personal assets in the event that the business is unable to repay the debt. Business loans with personal guarantees attached are typically unsecured loans because they are not collateralized through your business’s assets, such as commercial property or inventory.
A personal guarantee is usually signed during the loan application or approval process. It’s not uncommon for small business owners to use a personal guarantee since they are invested in the success of their business. Plus, they may not be able to qualify for a loan without one.
Under a personal guarantee, a creditor has a legal claim to the personal assets of the guarantor. This can include checking or savings accounts, cars, real estate, and other liquid assets. A small business owner seeking to provide a guarantee for a loan will typically need to provide their own credit history and financial background, along with their business’s credit information.
The benefit of a personal guarantee is that if you have a lot of personal assets, it mitigates the lender’s risk, which can lead to more credit and better terms, like lower rates. Well-established businesses with a long credit history may be able to acquire financing without a guarantee.
Now that we’re familiar with what a personal guarantee is, let’s take a look at the two types of personal guarantees: unlimited and limited guarantees.
When you sign an unlimited personal guarantee, you are agreeing to allow the lender to recover 100% of the loan amount in question, plus any legal fees associated with the loan through whatever means they have to.
If your business fails or you default on your loan for any reason, your lender can hire lawyers to gain a judgment in their favor, then go after your life savings, your retirement, your kid’s college fund, your house, your car, and any other assets they can find to cover the full cost of the loan, plus interest and their legal fees.
For example, if you still owe $50,000 and default on the loan, and your lender spends $5,000 in legal fees to gain a judgment in their favor, you will then owe $55,000, which can be legally taken from any part of your finances in order to make good on the loan.
These guarantees are called “unlimited” for a reason. They offer you as the borrower little-to-no financial protection if your business isn’t as successful as you planned.
On the other hand, limited personal guarantees set a dollar limit on what can be collected from you as the borrower in the event that you default on your loan.
Limited guarantees are often used when multiple business partners take out a loan for the company together. SBA standards state that anyone with a 20% or greater stake in the business should be part of the guaranteeing process. These guarantees help define each person’s piece of the debt pie should the company default on a business loan.
Limited guarantees are not without their own hangups, however. Before you agree with your business partners to sign a limited guarantee, check whether you’re signing a several guarantee or a joint and several guarantee.
With a several guarantee, each party has a predetermined percentage of liability. You’ll know from the beginning the maximum you might owe in a worst-case scenario, which will be a fixed percentage of the loan—usually proportionate to your stake in the company.
A joint and several guarantee, however, differs in that each party is potentially liable for the full amount of debt. The lender can’t recover more than it is owed, but it can seek up to the full amount from any of the parties listed on the guarantee. So if your business fails and then your business partner disappears or doesn’t have sufficient personal assets to cover his or her portion of the loan, your lender can come after you for both your stake in the guarantee, plus whatever portion remains unpaid from your partners.
The lines between limited and unlimited personal guarantees aren’t always completely clear. If legal language isn’t your forte, it’s worth it to hire a professional who can explain in detail the full ramifications of the guarantee before you sign. If you don’t, you could be on the hook for a lot more than you bargained for.
For example, say you own a sunglasses store, and the store goes out of business. If you signed a personal guarantee, your lender could seize the store and all the sunglass inventory inside, then require you to help them convert that inventory into cash. Depending on the terms of your personal guarantee, you may be expected to spend a pre-determined amount of time helping sell the remaining sunglasses to your contacts (competitors, wholesalers, etc.) in order to convert those assets into cash on their behalf.
After losing your business, the last thing you want to do is spend your time selling off the leftovers to the highest bidder without keeping a dime to show for it. A licensed attorney will be able to spot clauses like these and explain what they mean before you agree to anything. Your business attorney may even be able to red-line certain clauses in the contract and negotiate with the lender for more amicable guarantee terms.
Whether you have access to an attorney or not, look out for these gray areas in a personal guarantee agreement and proceed with caution.
In an effort to protect against borrower fraud and other “bad” acts, there may be a provision (often referred to as a “bad boy” guarantee) written into a limited personal guarantee that allows it to be converted into an unlimited one. This is designed to ensure that borrowers behave ethically and legally by, among other things, allowing a lender to seek justice against a fraudulent borrower without having to worry about the legal cost to do so.
Personal guarantees, even supposedly limited guarantees, are often intentionally vague and can include provisions and requirements from you as the borrower that you would never even dream of. Due to provisions like these, it’s important to read between the lines as best you can before signing a personal guarantee.
A personal guarantee is just one way a lender can protect their investment. If you don’t want to risk your personal assets, you have other options. Of course, no loan is truly ever unsecured, so you will need to secure your loan in one of the following ways instead.
A blanket business lien is like a personal guarantee but for your business’s assets, not your personal ones. It is a common legal claim 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 in order to collect the money owed to them.
If a lender files a blanket lien, they can essentially bankrupt your business in pursuit of repayment for the principal and the interest on your loan. Note that most loans that contain blanket business liens also require personal guarantees. This way, if your business assets aren’t enough to repay the debt, the lender can then dig into your personal assets.
If you have collateral to put up, you may be able to secure a collateralized 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 specific asset from the borrower and liquidate it for repayment of the loan. Collateralized loans are considered secured loans, as opposed to loans with personal guarantees or blanket business liens, which are considered unsecured. Generally speaking, it’s better to put up collateral for a loan, if you can, than to put all your personal and business assets at risk with a personal guarantee or lien. Traditional collateral examples include real property, inventory, cash, and unpaid invoices.
While you’re reviewing your business loan agreement, you may be wondering if a personal guarantee is worth the risk. This is really a question that can only be answered by you and your business partners, although you may want to also consult your business lawyer and accountant. There are some questions you can ask yourself to help you determine whether a personal guarantee is worth it, though. The first of which is: Do you have a plan in place to make sure you can pay back your loan on time and in full? Obviously businesses can go through the unexpected and end up with a few bad months or even going under, but you should still have a plan in place to help guide you and keep your business operating long enough to pay back your loan.
Second, you should ask whether you’ve read over the details of your loan and the terms around the guarantee. We do advise that you have a lawyer help you interpret the contract so there are no surprises down the line. If you’ve read it over along with your lawyer and you both decide it sounds fair, and you have a plan in place to pay back the loan, then a personal guarantee may be a viable option for your business.
Lastly, you should see if you can negotiate at all before accepting funding with a personal guarantee attached to it. Maybe you could have certain family assets excluded if you don’t want to put certain things on the line. Another possibility is asking if you could lower the guarantee to less than 100%.
Before you agree to any sort of personal guarantee, you have to look at your business and your finances objectively, understanding the real possibility that despite your best efforts and intentions, there is a chance your business could fail. Think through all the possible ways each provision within the agreement could affect your business and your personal finances down the line. In the end, you must ask yourself if the risk is worth the reward.
Ideally, you’ll pay back all of your business’s debts on time and in full and don’t need to worry about your personal assets coming into play. In the event that the unexpected happens, you should still have a contingency plan in place that will ensure your loan is paid. If you don’t, you may want to press pause on your loan search until your finances are on more stable ground—that way you won’t be jeopardizing your business or personal assets.
Meredith Wood is the founding editor of the Fundera Ledger and a vice president at Fundera.
Meredith launched the Fundera Ledger in 2014. She has specialized in financial advice for small business owners for almost a decade. Meredith is frequently sought out for her expertise in small business lending and financial management.