Both collateral and personal guarantees can help you get a small business loan by reducing the lender’s risk in case your business can’t repay the loan. Collateral is limited to specific business assets whereas personal guarantees can cover any (or all) of your current and future personal property.
They’re similar to each other because they both help the lender recoup losses if the borrower defaults, but they’re different in how the lender can recoup losses. Collateral is recorded in public records with a UCC filing, and the lender can immediately seize and sell assets if a borrower defaults. With personal guarantees, each state has laws that restrict exactly what a lender can seize in terms of personal property and how fast.
Some lenders will ask for collateral and not a personal guarantee when your business has been established, and the assets can recoup their losses. However, if your company is brand new, you may be asked to make a personal guarantee since you may not own any assets that can cover the cost of the loan. In other situations where there is risk of default and the assets could go down in value, the lender may ask you to make a personal guarantee on top of providing collateral. That’s why we put this guide together to help you navigate these situations.
We start by explaining what each item is and then we’ll go into situations where you should expect to be asked for one or the other, or both. You’ll also find ways to reduce your risk as a borrower.
Collateral for a business loan is the item or items a lender can pursue, seize, and sell to recoup their losses if you default on the loan.
When providing collateral on a loan application, you may list specific assets by using identifiers like vehicle identification numbers (VINs) and equipment serial numbers. There are also occasions when collateral is provided in a broader manner, such as with a “blanket” lien. This is when all your business assets are potentially tied to a given loan. When providing collateral, it’s best to be as specific as possible so that the lender cannot pursue all your assets in the event of a default.
Collateral can be almost any business asset including:
- Real estate
- Inventory
- Office supplies
- Intellectual property rights
- Other assets your lender agrees to
Lenders record collateral in public record with UCC filings submitted to the secretary of state in the state where the borrower’s business is located. This alerts other lenders to the tied-up assets and creates a legal document trail in case the borrower defaults, and the lender needs to take them to court.
It’s possible to use your house, stocks, or other personal assets as collateral for business loans if your lender agrees. Personal assets can work in the same way business assets would, and it’s up to the lender whether they decide to put in a UCC filing.
These assets will be identified in the business loan agreement and other legal documents depending on the asset. Here are a few examples.
- Personal real estate is secured with a mortgage or deed of trust recorded in county records.
- For vehicles, boats, and other property with titles, the lender will be added to the title certificate.
- Stocks and similar investments are pledged through “control” agreements with your broker.
- Other valuable property like art or jewelry will be listed on a UCC filing.
When you don’t have or don’t want to pledge specific business or personal assets, lenders will often ask for personal guarantees. Some lenders will require a personal guarantee regardless, in order to provide you with financing. Further, depending on the loan amount versus the collateral value, a lender might ask you to provide both collateral and a personal guarantee. Here’s what a personal guarantee is.
What is a personal guarantee?
A personal guarantee is a promise that if your business can’t repay the loan, you’ll repay it from personal finances. This can help you get a business loan for a new business or when your existing business doesn’t have enough assets to pledge as collateral. It can also be used as an extra incentive for a lender to give you lower rates.
There are two types of personal guarantees:
- Unlimited personal guarantees hold you responsible until the loan is satisfied. That doesn’t mean the lender will seize everything you own, though. It means you remain liable until the loan is paid off.
- Limited personal guarantees make it so that the guarantee is only good for a limited time, the dollar amount you’re promising to repay, or a percentage of the loan.
Personal guarantees don’t list assets in the same way UCC filings list collateral. However, your personal savings, investments, real estate, cars, and other property will all factor into the personal net worth check that your lender will do to make sure you can actually repay the loan with your assets if you default.
It’s important to check with a legal expert for your state before agreeing to a personal guarantee because each state has laws restricting exactly what and how much lenders can pursue in terms of your property, garnishing wages, or putting levies on bank accounts.
When collateral or personal guarantees are the best option
The best option between providing collateral or making a personal guarantee depends on your current financial situation, forecasted business plan, and what assets you have available in your business and personal life. Here are some examples:
- Start-ups without any assets will rely heavily on personal guarantees.
- Established companies expanding to new locations are better off using collateral because you don’t have to risk personal assets.
- New real estate investors can use the property they purchase as collateral instead of a personal guarantee.
- An ultra-high net worth individual could use a personal guarantee to avoid tying up assets with UCC filings and still get great terms on a business loan because the lender has low risk.
- Three partners in a business can use their office to secure 25% of a loan and then make personal guarantees amounting to 25% each to make up the difference.
Certain loan types will also have built-in collateral so you shouldn’t typically have to pledge anything additional or make a personal guarantee:
- Equipment financing loans use the equipment you purchase as collateral.
- SBA 504 loans are fully collateralized when used to buy real estate or long-term machinery and equipment.
- Inventory financing loans can use the inventory as collateral.
Making a personal guarantee and offering business assets as collateral can both help you get approved for small business loans and reduce the risk of lenders, potentially giving you access to better interest rates. Which one is best depends on your business and personal situation and what your lender will accept. Sometimes, using both together can help get you the lowest rate or the largest loan possible.
