Personal guarantees can be leveraged to take business loans with more favourable terms, at the cost of being personally liable should the business be unable to make repayments. Despite this considerable risk, personal guarantees can still be an excellent tool for businesses looking to raise capital. In this article, we will discuss what personal guarantees could do for you, and what you need to know before signing your name along the dotted line.

What is a personal guarantee?

In the context of taking loans, personal guarantees act as an assurance that the debt will be paid. Suppose a business takes out a loan, wherein the business owner makes a personal guarantee as part of the terms and conditions of the loan. In that case, they will be held personally responsible should the business fail to pay. The business owner will have the outstanding debt transferred to their person, which must be covered with personal finances, or through the sale of personally owned assets. Naturally, this carries much more risk than loans that don’t require a personal guarantee.

Many personal guarantees will require assets to be put on the line, similar in nature to a secured loan. The limits of this requirement will vary depending on the type of personal guarantee, which we will discuss later. Some personal guarantees will demand bank accounts or investment portfolios to be used as security, while others will expect real estate or other, similar assets. Before you sign your guarantee, ensure you know exactly what assets are at risk in the event you become responsible for the debt.

Personal guarantees are generally to shield loan providers from financial losses, especially for high-risk borrowers. If a lender takes on a high-risk case without requesting a personal guarantee, they will have no recourse in the event the business defaults. In such an instance, the outstanding debt will have no hope of being paid. Physical assets act as a further layer of protection. Assuring lenders that even if a business defaults, the seizure and sale of business assets can cover the sum.

Types of personal guarantee

Although there are some variations, personal guarantees typically fall into one of two camps. The first category is limited guarantees, while the other is unlimited guarantees. The main differences between the two involve the extent to which you are responsible for the debt, and exactly what can be used to cover it.

Unlimited personal guarantees

An unlimited guarantee is the type that places total responsibility squarely upon your shoulders. By signing an unlimited personal guarantee, you are nominating yourself as the sole guarantor for the loan. This means that by agreeing to take out the loan, your finances, and even your physical assets, are on the line if the business defaults.

Limited personal guarantees

A limited personal guarantee is a bit more forgiving to an individual. This type of guarantee divides responsibility for the loan amount between the signatories. Meaning no single person will bear full responsibility. Each signatory will be expected to pay an equal percentage of the debt or an overall sum, in the event the business cannot pay its debt.

When are personal guarantees required?

Personal guarantees are usually required in one of two cases. A small business applies for a loan, or a business with a high risk of default does. This is to provide lenders with a contingency if the business defaults. This allows businesses to take out riskier loans, and lenders to provide capital without taking on much risk of losing their money.

While there are several types of business loans that require personal guarantees, they aren’t a universal requirement. Secured finance, despite being quite similar to the point of a personal guarantee, is one such example. This is due to secured finance requiring physical assets to be used as collateral, making a personal guarantee redundant.

However, many forms of business finance will require a personal guarantee. If a lender deems your business at high risk of default, or one without much credit history. Both short and long-term business loans tend to come with personal guarantee requirements, for example. Although they can be quite flexible, allowing businesses to raise capital for a wide range of reasons, this flexibility comes at the cost of security. In most cases, lenders will require a personal guarantee. Though, you may be able to offer physical assets as collateral, depending on your lender. Another form of business finance requiring a personal guarantee is an SBA loan. This type of loan requires anyone with a 20% stake in the business to sign an unlimited personal guarantee.

Advantages of personal guarantees

Personal guarantees, like any financial tool, offer businesses certain benefits. The most significant benefit is that they can expand what loans for which your business may be eligible. As personal guarantees assure lenders that debts won’t be left unpaid. They are much more likely to accept loan applications from businesses without a stellar credit history.

In addition to making your business eligible for a wider range of loans, personal guarantees can also make loan terms more favourable. For example, in exchange for assuming personal responsibility for the loan, you may have access to loans of a higher value. A lower interest rate, or even an extended loan duration. These benefits come into play regardless of whether a personal guarantee is necessary. Leading to many business owners signing a personal guarantee in order to reap said benefits.

Disadvantages of personal guarantees

Although there are notable benefits to personal guarantees, they carry considerable disadvantages too. Most notably is the fact that your personal finances and assets are at risk should the business be unable to pay. Not only this, but your personal credit history is liable to take a knock as a result. Moreover, personal guarantees are notoriously difficult to wriggle out of. In most cases, only the filing of personal bankruptcy will absolve you of your responsibility to pay off the loan.

Final thoughts

Personal guarantees can provide businesses with access to more loans with more advantageous terms, though at the cost of added risk to the individual. If you are considering signing a personal guarantee, be sure to thoroughly acquaint yourself with the terms of the contract. Some personal guarantees carry more risk than others, making it incredibly important to understand what you are signing up for. If your business defaults, you may find yourself with some nasty surprises. However, for a business that carries a very low risk of defaulting, personal guarantees could make your capital-raising efforts significantly easier.