Why is a personal guarantee required?
Providing a personal guarantee means that the individual assumes personal responsibility for the balance if the company is unable to repay the debt. Personal guarantees provide an additional level of protection to loan originators who want to ensure they are repaid. Personal guarantees are one of the aspects of financing a small business that entrepreneurs love to hate. When you apply for a small business loan, you may be asked to provide a personal guarantee for the loan in whole or in part.
In fact, it is a common expectation today to risk your own finances. The lender cannot reclaim more than they are owed, but they can claim the full amount from any of the parties listed in the guarantee. It’s often better for your business to fail than to take personal liability for your company’s costs or debts. However, there are a few questions you can ask yourself to determine whether a personal guarantee is worth it.
If you are asked to sign a personal guarantee for a business lease or loan, you can minimize your personal financial commitment in this situation if you know what comes with that guarantee and if you can negotiate terms. Although this is a common provision in the fine print of a business loan, a personal guarantee can put your family’s finances at risk. The main benefit of signing a personal guarantee is that it can increase your chances of getting approved for a business loan, especially if your personal credit score is strong. The main risk when signing a personal guarantee is that you are responsible for repaying the loan with personal assets if your company fails to make its debt payments.
Landlords may be willing to negotiate rent and common area (CAM) maintenance fees, but one thing they’ll likely insist on is a personal guarantee. A personal guarantee can put your personal credit rating at risk in addition to your company’s creditworthiness. So if you sign a five-year note, you can ask that the warranty is only valid for the first two or three years. The difference between the two focuses on the extent of your liability and how long the warranty lasts.
An unlimited guarantee, also known as an unconditional guarantee, means that guarantors must pay all amounts due until the note is paid in full. A personal guarantee is a provision that a lender includes in a business loan agreement that requires owners to be personally responsible for their company’s debts in the event of default. Providing corporate finance without personal guarantees can be risky for lenders as more than 20 percent of small businesses fail in the first year. It also signals to the bank that you are ready to put your personal wealth on the line for your company.
If a secured business loan is not an option, ask business partners or other owners to also sign personal guarantee credit agreements so that everyone is liable for their pro rata share.