The Personal Guarantee Loan: What it Means for Your Business
When starting a small business, you may be required to provide what is called a personal guarantee for any business loans you take out. A personal guarantee exposes your personal assets to legal action and collection by lenders if you should default on your loan. However, personal guarantee loans also help small businesses get their start and provide money for unexpected expenses.
Since small business owners are the types of borrowers who most often have to sign a personal guarantee, we will talk about the various types of personal guarantees and what they mean for you and your business.
Personal Guarantees: Understanding the Basics
What is a personal guarantee? A personal guarantee is where you, the borrower, agree in writing to allow some or all of your assets to be subject to recovery legal action by a lender in the case that you default on a business loan. Normally, under an LLC or S corporation legal arrangement, a corporation is treated as another legal identity that exists independently from its shareholders. This means that in civil court, business owners cannot be held personally liable for attempts to recover assets owned by the company. This is one of the protections that makes business possible in the U.S., as this shield against liability lessens investment risk.
However, lenders may not wish to lend a business money based on various risk factors. One way to overcome this reluctance is a personal guarantee on behalf of one or more of the business owners. If a personal guarantee is signed, this means that a lender can initiate recovery proceedings against the assets of the signers of the guarantee. A personal guarantee on a business loan may be what is needed for money to be lent to a business. For most small business lending, a small business loan personal guarantee of this type is essential to get needed funds.
Why Make a Personal Guarantee?
A personal guarantee may be the only option to get cash for either startup costs or to cover emergency expenses until accounts receivable can be settled. A personal guarantee can be an important tool for business owners to raise cash, and, if used correctly, can be used to great effect to get a business over a rough spot or to make a great business idea happen.
Entrepreneurs who have extensive assets and great credit can use personal guarantees to help launch new businesses. Personal guarantees give lenders confidence, which is good news for small business owners. Anyone who makes a personal guarantee is called a personal guarantor.
Personal Guarantee: Risks Versus Rewards
The question of whether or not signing a personal guarantee is worth the risk is a fraught one. Of course, you should always consult with your lawyer and your accountant if you’re thinking about signing a personal guarantee. Here are also a few things to consider:
Payback Plan
Do you have a plan in place to pay back the loan? Is it a factor loan, a term loan, or something else? Even if business circumstances are uncertain, a plan should be in place to pay back any money you borrow. Your lenders will certainly ask you about the when and how of your payback plan.
Contract Details
Whatever you do, make sure that you read over the contract details with your lawyer and your accountant. Your accountant can make sure that your payback plan makes sense and can address the business uses of a personal guarantor business loan, while your lawyer can double-check the language of the guarantee and make sure the terms are fair regarding the liquidation of assets and inventory or use of collateral. You may be even able to find points that you can negotiate with the lender so that you can achieve a more favorable deal.
Types of Personal Guarantees
Here we examine the various kinds of bank loan personal guarantee.
Unlimited Personal Guarantee
An unlimited personal guarantee is exactly that. A lender may take action against you to recover the entirety of the debt plus legal fees, for as much of your assets as it will take, in the event of a personal guarantee business loan default.
Limited Personal Guarantee
A limited personal guarantee is where the lender may only initiate proceedings against some of your assets. Usually, the limit is a set dollar amount. This type of personal guarantee is used when multiple business owners seek to help their business qualify for a loan.
This can also include a personal guarantee that is secured by defined collateral. This is called a secured personal guarantee.
Several Guarantee Versus Joint and Several Guarantee
It’s important to note the difference between a several guarantee versus a joint and several guarantee. With a Several Guarantee, each participant is only responsible for a set percentage of the debt obligation. With a Joint and Several Guarantee, each party is potentially liable for the entirety of the debt. This is important if a business partner disappears or can’t contribute to debt recovery.
Understanding the Personal Guarantee: L3 Funding Can Help
At L3 Funding, we work with business owners of all sizes to help them understand the impact of agreements like personal guarantees. Do you have personal guarantee questions? Contact us for answers about this topic as well as information on small business working capital.