Personal Guarantees
Personal guarantees are a common request for all new business owners. Whether it is the bank or other lender, the landlord at your new office, or the copy wanting to lease you equipment; you can be certain that the other side will request a personal guarantee. This article will attempt to answer some common questions regarding guarantees for new business owners.
What is a personal guarantee?
A personal guarantee is an unsecured promise from an individual to make loan payments or pay some other debt (such as rent) when a business is not able to do so. As the promises is unsecured it is not backed up by a specific asset, such as your personal residence, in which case, the asset would be considered collateral.
Why do lenders or landlords request a guarantee?
This is the question every small business owner wants to know the answer to, although the lenders often don’t provide a good answer. They simply say it is a requirement. In reality the answer is that a personal guarantee is extra insurance for the lender that you are serious about your business and also that you are serious about repaying the loan.
Here are some key reasons why small business lenders require–and will continue to require–your personal guarantee:
- A personal guarantee is a psychological reminder to you of your company’s obligation to make timely payments and eventually repay the loan. If it fails, you are responsible. A personal guarantee shows your commitment to being a responsible business manager and repaying your business loan.
- Financial affairs of a small business are commonly intertwined with the personal financial affairs of its owners, so it is logical and reasonable to ask you to promise to repay the loan, if your company can’t.
- A personal guarantee offers lenders the ability to follow the due process to recover the business loan from you personally. In essence, it is a way to go after your personal assets, commonly your personal residence, through the legal system. Without the guarantee, there is not much a lender can do if your business defaults on a loan and is unable to repay it.
Is a personal guarantee required for all small business loans?
Almost all small business loans require personal guarantees from business owners. This is not to say that there aren’t lenders who will lend without personal guarantees. Business credit-card loans are the most common example of a business loan without the personal guarantee. The rest will vary from lender to lender, and you will have to do your research to locate lenders who will not ask for or will waive the personal guarantee. You will have a greater chance of finding lenders who might be willing to waive the personal guarantee–if your company’s financial condition is strong enough to stand on its own. In addition, as your company grows in size and revenue, lenders generally will be less likely to require personal guarantees.
Is a personal guarantee required for all leases?
Again, almost all landlords request or require that a new tenant provides a personal guarantee. Occasionally a tenant will be able to have no guarantee or perhaps limit the application of the guarantee to the first few years of the lease. However, if your business is new except to personally guarantee your lease. Like small business loans, the likelihood or removing or limiting a guarantee is greater if your business has established credit and has been in existence for a longer period of time.
Some recommendations for small business owners faced with signing personal guarantees:
- Carefully review the personal guarantee agreement. You should have a lawyer review the paperwork for you. A typical guarantee agreement states that not only will you be liable for the loan obligations of your company, but you may also be responsible for default interest, legal, and other fees.
- Think twice about providing your personal guarantee, particularly when you do not have to. This includes situations when your business is strong financially or can offer lenders something they would want, for example significant deposits, or using other bank products and services that would generate considerable income for the lender. If your company and you personally can bring more business to a lender than just loan income, the lender might consider waiving the guarantee.
- Think carefully about giving your personal guarantee for a business loan when you are not part of the management team and do not know what’s going on with that company. If you do not have ownership or some other “consideration” in the company, you should not be offering your guarantee and lenders should not be accepting it.
Signing a personal guarantee comes with risks, mainly related to your obligation to repay a business loan and the lender’s ability to go after your personal assets if you don’t. However, there are benefits. The main benefit is securing a business loan you otherwise might not get.
The key is not to obsess with the issue, but rather focus on limiting the amount of debt and making sure that your company generates sufficient cash flow to make debt payments. A personal guarantee is the reality of life for most small businesses, but it is also a decision that needs to be made with caution.