If you’re in the process of securing a small business loan, chances are you’ll be asked by your lender to provide a personal guarantee of that loan. This post provides an outline of the two most common types of personal guarantees to help you understand what each is and how they might impact you and your business.
A personal guarantee is an unsecured, written promise from the business owner pledging personal payment on the loan in the event the business itself would not be able to make payments. A personal guarantee might also be required from key company personnel – those without whom the business would not be able to operate. Since it’s unsecured, a personal guarantee is not tied to a specific asset of the owner(s).
Two of the most common types of personal guarantees are Unlimited Personal Guarantees and Limited Personal Guarantees:
- Unlimited Personal Guarantees: When you sign an unlimited personal guarantee, you agree to allow the lender to recover the entire loan amount, plus interest and legal fees, if the company defaults on the loan. This may include money from savings and college funds and possibly other personal assets, such as your house or car. The creditor has the right to collect against the guarantee without attempting to collect against the company.
- Limited Personal Guarantees: Limited personal guarantees set a dollar limit on what can be collected from the borrower in the event the company defaults on the loan. This is often used when multiple business partners take out a loan for the company together. The Small Business Administration (SBA) currently requires that all loans it guarantees are personally guaranteed by anyone with a 20% or greater ownership stake in the business. As with an unlimited personal guarantee, the creditor has the right to collect against the guarantee without attempting to collect against the company.
The purpose of a personal loan guarantee is to limit the risk of default lenders face by having borrowers have some “skin in the game.” Personal guarantees are fairly common in small business loans, so it’s important that you take a look at your business and your personal finances and understand all the possible ways a guarantee could affect both in the event the business doesn’t succeed.
Before you make a final decision about your business loan, consult with your business banker to help ensure you’re making the most practical decision for both your personal finances and the long-term success of your business – and to get expert guidance on the right type of loan for your situation.
If you’re planning on seeking a loan, use our Business Loan Application Checklist to help prepare you for the process. This handy guide provides an overview of the information you’ll want to present to your banker as you work together to identify the best type of loan for your situation. To get your complimentary copy, click below.