A business loan is more of a necessity than a business decision. It may be the only way to amass funding for your company. The majority of business loans come in the form of either a credit card, which is basically an unsecured loan with a high APR, or a loan specifically taken out for purposes of running the business, secured by the owner of the business.
But financial institutions often ask for a guarantee before issuing a loan when the business is below a certain threshold in its turnover, is not mature enough or carries some inherent risk flagged by the lender. Loans with a personal guarantee refer to those where a business owner agrees to pay the balance of a loan, even if the business defaults or is unable to pay.
The lender can then hold that borrower liable for the unpaid balance and for an amount that may have been realized after liquidating the collateral for the loan. Typically, banks will require anyone with an ownership stake of 20% or more in the business to sign a personal guarantee.
Essentially, a personal guarantee is nothing but a legal document that the borrower signs enabling the lender to hold them liable or responsible if the business is unable to repay the loan or if the collateral they have submitted turns out to be inadequate. In most cases, a personal guarantee is required to secure a business loan, a business credit card or a line of credit, and that even includes loans from the Small Business Administration.
This may be in addition to collateral that the lender already required. However, a non-recourse loan allows the lender to seize only the collateral as specified in the loan agreement, regardless of whether its value covers the whole debt.
To stand as a personal guarantor, the borrower’s personal credit rating is checked, which can go one of two ways. Either the business is hurt by the guarantor’s too-low credit rating, or the guarantor’s rating is put in jeopardy of the business not being able to perform and defaulting. And as usual, conducting a credit rating check does also affect the credit score.
The only requirement for the guarantor is to stand in, it does not require them to put in money upfront, or to keep the money in escrow or set it aside. It’s the legal equivalent of an IOU note.
Despite the inherent risks, most of the time acting as a personal guarantor on a loan is the only way that small business owners can secure funding. Meanwhile, most businesses require a personal guarantor to back every loan nowadays.
For businesses of a certain size, a guarantee may not be required. However, signing as a personal guarantor may qualify a business for better terms or even a lower interest rate. If, on the other hand, signing a guarantee does not improve the terms of your loan, then the increase in liability may not be worth your while.
