When seeking financing for your small business, you may come across the term “personal guarantee.” This concept is crucial for both borrowers and lenders, as it involves a legally binding commitment that can significantly impact your financial responsibilities. Here’s a detailed look at what personal guarantees are, how they work, and their implications for your business.

What is a Personal Guarantee?

A personal guarantee is a commitment made by an individual (often the business owner or a key executive) to repay a business loan if the business itself defaults. Essentially, it provides the lender with an additional layer of security, ensuring that the loan will be repaid even if the business fails to meet its obligations1.

How Do Personal Guarantees Work?

When a business applies for a loan, the lender may require a personal guarantee from the borrower. This means that the guarantor (the individual providing the guarantee) is personally liable for the debt if the business cannot repay it1. This is true even if the business operates as a separate legal entity, such as a limited liability company (LLC) or corporation.

Types of Personal Guarantees

There are different types of personal guarantees, each with its own legal obligations and implications:

• Unlimited Guaranty: The guarantor is responsible for the entire loan amount, including principal, interest, and any associated fees. This exposes the guarantor to significant financial risk, as their personal assets are fully at stake2.
• Limited Guaranty: The guarantor’s liability is limited to a specific amount or percentage of the loan. This reduces the financial risk compared to an unlimited guaranty2.

Why Do Lenders Require Personal Guarantees?

Lenders require personal guarantees to reduce their risk when approving a loan. This is especially important for new businesses, companies with limited credit history, or businesses with few assets or collateral3. A personal guarantee demonstrates the borrower’s commitment to repaying the loan and provides the lender with additional security.

Implications for Borrowers

While personal guarantees can help small businesses gain access to capital, they also come with significant risks. In the event of default, the guarantor’s personal finances and credit score are at risk1. It’s essential for borrowers to understand the full extent of their obligations and consider the potential consequences before agreeing to a personal guarantee.

Conclusion

Personal guarantees are a common requirement in business loans, providing lenders with added security and borrowers with access to funding. However, they come with significant responsibilities and risks. Before entering into a personal guarantee, it’s crucial to fully understand the terms and implications, and consider seeking professional advice to make informed decisions.