Collateral vs. Personal Guarantees: What the Difference Means for Your Business Loan

There’s a lot of terms to understand when comparing business loan options and looking at your financing offer. A business loan commonly requires a form of collateral – whether that is physical collateral, a personal guarantee, or a UCC filing. Knowing what these terms entail for your business can help you make empowered decisions best suited to your needs. So, what do these terms mean and how do they play into your financing offer? Let’s dive in. 

First, it’s important to understand the common denominator between these three terms. Collateral, personal guarantees, and UCC filing all serve to reduce risk for the lender when approving a loan. These provisions on a loan agreement provide protection for both the borrower and lender – in the case of default, there is a provision to fall back on.  

Collateral on a business loan refers to a tangible asset offered up as collateral on the loan agreement. These assets act as a form of security for the lender, reducing their risk in case of default. Collateral can include real estate, equipment, inventory, or other valuable items that can be seized if the borrower fails to repay the loan. If the borrower fails to repay the loan, the lender has the right to seize and sell the collateral to recover the outstanding debt, providing assurance for both parties involved in the lending agreement. 

Tying one’s vehicle or real estate – or in many business loans, the business equipment – can be daunting for a business owner seeking financing. It also isn’t always a possibility – not every business owner has assets to offer as collateral. Luckily, there’s other options to consider for your business financing. 

A personal guarantee in a business loan is a commitment made by an individual, typically the business owner or a key stakeholder, to personally repay the loan if the business is unable to do so. It serves as an additional layer of security for the lender, offering assurance that the debt will be repaid even if the business fails. Personal assets, such as savings, investments, or real estate, may be used to fulfill the guarantee in case of default. It is generally considered to be just as the name implies: a personal guarantee the borrower will repay the loan. 

There are two types of personal guarantees: 

Unlimited personal guarantee: The guarantor is required to repay the loan in full with no exceptions.  

Limited personal guarantee: This limits the time, dollar amount, or percentage of the loan the borrower is liable for.  

A UCC (Uniform Commercial Code) filing is a legal claim that a lender can place on a business’s assets as collateral for a loan. It’s a common practice in commercial lending to secure interests in personal property. By filing a UCC financing statement with the appropriate government agency, the lender establishes a public record of their claim on the borrower’s assets. In the event of default, the lender may seize and sell the collateral to recover the outstanding debt. A UCC filing is typically used in junction with a personal guarantee. 

A personal guarantee and a UCC filing are both methods used by lenders to secure business loans, but they operate differently. A personal guarantee involves an individual, often the business owner, pledging to repay the loan personally if the business cannot. It leverages personal assets as a backup. On the other hand, a UCC filing is a legal claim on the business’s assets, filed by the lender. It provides security by allowing the lender to seize and sell specific assets if the business defaults. While both offer protection for the lender, a personal guarantee involves personal liability, while a UCC filing targets business assets. 

Traditional bank business loans typically ask for collateral as part of their loan agreement – which often can be a barrier to entry for many business owners. Similarly, SBA loans often require collateral from the borrower. While the SBA secures a portion of the loan, the contract often requires collateral and a personal guarantee from the borrower.  

Alternative loans can vary in what is required on their financing contracts – it’s common for an alternative lender to ask for a personal guarantee and UCC filing in lieu of collateral, but it varies by lender. Make sure you ask your financing specialist what terms can be offered for your loan agreement. 

Choosing between a personal guarantee, UCC filing, or collateral for a business loan depends on various factors. Consider the business’s financial stability, the value and liquidity of its assets, and the willingness of stakeholders to assume personal liability. A personal guarantee may be suitable for smaller businesses with limited assets, offering flexibility but personal risk. UCC filings are preferable when significant assets are involved, providing security without individual liability. UCC filings and personal guarantees can be a great way to secure a no collateral loan. Collateral suits businesses with valuable assets, offering tangible security but potentially limiting flexibility. Ultimately, weigh the benefits, risks, and needs of the business to determine the most suitable option.