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Personal Guarantees: How They Affect Your Business Loans

Learn how personal guarantees work when it comes to applying for business loans. Find out how it ties in with your personal credit too.

Your business needs a loan. A lender is willing to give it to you.

But there is an “if” involved. That is, a lender will give you a business loan -- if you sign a personal guarantee.

You’re desperate for a business loan. You’re sure it is the only chance your business has got.

You say, “You require a personal loan guarantee for business loans? Sure, fine. "Where do I sign?”

But, of course, it’s never a good idea to sign anything without fully understanding what you’re getting yourself into.

So if you’ve heard the term, “personal guarantee” thrown around without fully understanding what that means, you’ll want to become very familiar with these two words before you sign on the dotted line.

What is a Personal Guarantee?

A personal guarantee is a promise that, in the event that your business can’t pay back a loan, you will pay out of your own pocket -- even if your business fails.

If you take out money, for instance, to buy some expensive equipment that your business needs, and your business bombs and shuts its doors forever, and that loan goes unpaid – well, your banker can come after you to get the money.

You could have a debt collector calling at all hours for years to come.

You could potentially wind up in court.

In theory, if this was a really, really big business loan, you could lose a lot, like your house and car.

Might be needed to get the business going

Also, in theory, the business loan could be just what your startup business needs (established business owners may be asked to sign a personal guarantee but it’s most common with startups), and you may easily pay it off.

Years later, when you pass your business onto your kids or sell it to a giant corporation or whatever, you may someday be lying on the beach of your own personal island and thinking, “Signing a personal guarantee was the smartest thing I ever did.” 

When personal guarantees are required

As for why personal guarantees are sometimes required, it’s fairly common for a bank to ask for one if a business is new.

After all, if a business startup is just getting moving, it may not have much collateral.

Maybe your business has no expensive equipment yet – and that may be well why you need the loan. You need to buy the equipment you need to run your business. Maybe your business is leasing a building, so there is no building as collateral.

Whatever the situation, sometimes, a lender needs to at least know that the business owner is at least willing to take responsibility to pay for a loan if the business underperforms.

If you’re willing to take responsibility, the lender is more likely to give you a business loan.

Impact on Qualification & Rates on Business Loans

Sometimes, a personal guarantee often doesn’t affect your interest rates on a business loan. 

Sometimes, it does.

It isn’t a very satisfying answer, but all lenders are different.

The reality is:

A personal guarantee often means the difference between getting any loan or no loan.

But some lenders may agree to give you a lower and more reasonable interest rate with a personal guarantee, and without it, a much higher interest rate.

Link to Personal Credit

Here’s the good news.

Check with your lender just to make sure, but typically, a personal guarantee on a business loan will not affect your credit if you’re making regular payments on your loan.

Why?

The business loan won’t land on your personal credit report.

So you should be able to, in theory, take out a business loan with a personal guarantee at the same time you’re looking for financing for a new house.

Your personal and business lives are separate.

Missed payments will hurt personal credit

Here's the bad news.

If your business struggles to make those payments, and it gets behind, eventually, at some point, your personal and business lives will start to connect.

Your business loan will appear on your credit report as an unpaid loan, and then, yes, your credit score will be affected.

And so if this all happens right around the time you start looking to buy a new house or a car, you could run into trouble getting a personal loan.

Personal liability for defaults.

The other risk, as noted, is that if you can’t pay the loan back, and if this is a really serious business loan, you may be taken to court.

You could lose a lot.

After all, if your business fails, you may not have much money, and it could be next to impossible to pay off the loan, at least any time soon.

That’s where personal guarantee insurance might come in handy. (Yes, there is an insurance policy for everything.)

Personal guarantee insurance will usually cover up to 70 percent of the insured’s net liability.

It depends on the type of coverage you’re getting and the policy’s rules.

That sounds good, but keep in mind that even with PGI, to get 70 percent of the debt paid, you’d have to liquidate your business’s assets first, and you’re still on the hook for 30 percent of the debt.

Personal guarantee insurance can save you from complete decimation, but you could still come away from the experience pretty beaten up, financially speaking.

When It Makes Sense to Sign a Personal Guarantee

It may make a lot of sense – if you think your business is going to be a huge success.

If you think about it, a personal guarantee is a sign of how you feel about your business.

Look:

Every startup is a risk.

If you start a business, you’re rolling the dice. Think about all the people who were starting businesses right before the pandemic – the restaurants and hotels, in particular.

Some people probably had extremely strong business models but were still wiped out because suddenly, they had no customers for months.

So even in the best of circumstances, starting a business is a risk.

But sometimes you know in your heart that your business is kind of a fifty-fifty proposition. 

Maybe you’re opening up something unusual in a community that may or may not go for your idea. You love your business idea but truly aren’t sure if people are going to go for it.

Well, you probably shouldn’t sign a personal guarantee, unless the loan isn’t all that much, and you’re confident that you’re going to be able to pay it off.

If your business model seems strong, and you really do have a great feeling about it, then it probably makes sense to sign a personal loan guarantee.

But, again, it’s a risk. You could have another pandemic show up, a natural weather disaster or an asteroid crash into your building.

Maybe your business partner absconds with your money.

Personal guarantee with business partners

Speaking of which, you could take out a personal guarantee with your business partner.

That is, if you have a partner or partners, you could sign a limited personal guarantee, where you’d be responsible for half of the loan or a third or however it works out.

Overall, a lot of business people do sign personal guarantees for business loans, and whether this is a good idea or not probably comes down to your gut.

How do you feel about your startup’s odds? Do you have a plan to pay off the debt if the worst happens, and your business fails, and it can’t pay off the business loan?

Depending how you answer those questions will depend on whether you should tell your lender, “Yes, I’m going to sign a personal guarantee,” or, “No, I’m not signing one.”

How to Get a Business Loan Without a Personal Guarantee

Yes, absolutely. If you’ve had a business for awhile, say, three or four years, and you have a history of making payments on business loans, you simply might not be asked to sign a personal guarantee.

Or if the loan isn’t all that much, such as $5,000 instead of $50,000 or $500,000, you might not be asked to sign a contract stating that you’ll pay up, if your business fails to.

Business credit

One thing you may want to work on, to improve your odds of getting a business loan and not having to offer a personal guarantee, is your business credit.

If you have a healthy business credit score, the odds are less that you’ll be asked to sign a personal guarantee.

And how do you even know if you have a business credit score?

There are three major business credit bureaus (Dun & Bradstreet, Equifax and Experian), not to be confused with the three major personal credit bureaus (Equifax, Experian and TransUnion).

If you contact the business credit bureaus, they’ll give you a full copy of your business credit report. (You may have to pay; prices vary from free to not free, depending who you’re dealing with.)

You may learn that you don’t have a business credit report.

In any case, you’ll likely start to create a business credit report and thus a business credit score if you take several steps:

  1. Incorporate your business. Or form an LLC (limited liability company).
  2. Get a federal employer identification number.
  3. Open a business bank account.
  4. You’ll want a business phone line and make sure it’s listed.

After that, you’ll want to start taking out loans – in your businesses’ name. And one of the easiest ways to do that is to open up a business credit card account.

Yes, you can also do things like take out loans from a supplier or vendor, where they offer you credit.

But getting a business credit card is a great way to start birthing your business credit score.

Possible to Remove Personal Guarantee From Existing business Loan

It is possible.

But it’s hard, and it all depends on how your lender feels about it.

First of all, let’s look at this from your lender’s perspective. If you come waltzing into a banker’s office and ask to have a personal guarantee removed from an existing business loan, will that make them more confident that your business is going to do well? Or less?

If your business was doing well, and you were going to have no trouble paying off the loan, you wouldn’t bother to ask to have the personal guarantee removed.

There must be a reason you want off the hook, and that’s because your business is struggling.

That may not be true, but that’s what a lender is likely to think.

Still, if the business is thriving, and you’re able to offer evidence that it’s doing well and perhaps offer alternative collateral instead of your personal guarantee, you may be able to get out of it.

But because it can be challenging to get a personal guarantee removed, that’s why you want to think about it long and hard before you make the offer.

The Bottom Line 

If a lender wants you to sign a personal guarantee on a business loan, there’s nothing wrong with doing so.

It’s quite common, and you aren’t doing something that’s considered crazy.

But there are risks, and signing a personal guarantee may be a bad decision if you don’t have much of a business plan.

Still, if you believe in your company, and you need a business loan, a personal guarantee may be the best chance your startup has for opening its doors. Which is why you may end up deciding to sign on the dotted line.

After all, if you don’t believe in your own business, why should anyone else?

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