Personal guarantees are when a business owner or the co-owners of a business use personal assets like their car or house as collateral on a business financial product like a small business loan or business credit card so that they can reduce their risk as a borrower and get approved by a creditor for financing.
The personal guarantee is a legally binding agreement that allows the company providing financing (the creditor) a way to recover their losses by seizing the personal assets of the person or people that made the guarantee if the company defaults on paying the money back.
There are two types of personal guarantees, limited and unlimited.
- A limited personal guarantee is when the borrower is only responsible for a specific amount of debt owed.
- An unlimited personal guarantee is when the creditor can continue to seize personal assets until the debt is fully paid back.
Personal guarantees are common for business financial products and nothing to worry about, as long as the business does not default on making payments. Depending on your relationship with the lender or financial institution, and your ability to make your company more creditworthy, you may be able to get the personal guarantee requirement removed so that your business can borrow money without needing you to leverage personal assets.
Why Personal Guarantees Are Required on Business Loans & Credit Cards
Personal guarantees are required by creditors when the company borrowing money or taking a line of credit does not have:
- Enough of a business history or track record of success and stability
- Cash flow in their business bank accounts on a regular basis
- Collateral owned by their business to offset the lender’s risk
When the borrower does not have enough of these to make themselves creditworthy, the creditor needs assurance that they are making a smart financial decision.
By committing personal assets as a backup for the lender, it reduces the financial institution’s risk if the company defaults on payments and shows the business owner or owners are willing to risk their own financial well-being. Having a personal commitment is a sign that the owners will spend the borrowed money from a loan, credit card, line of credit, or other financial product wisely.
Note: In addition to the above situations, some financial institutions simply have this as their standard policy to require personal guarantees due to risk.
When Personal Guarantees Are and Are Not Required
If you’ve never applied for a business financial product before, it can be a shock to hear that you may have to risk your house for a business loan, business credit card, or other type of corporate financing. But don’t worry, at a certain point in time you may no longer have to make these commitments. Once you are more creditworthy, you may be able to bypass the need for a personal guarantee, depending on the lender.
When They’re Required
Personal guarantees are required to get business financing when a company:
- Does not have enough of a financial history to show fiscal responsibility and long-term cash flow.
- Lacks the amount of owned assets to place for collateral.
- Has a lot of assets but they’re committed to another financial product via a UCC lien as the borrower already has a business loan.
- Uses assets that depreciate in value, making the collateral less valuable during the duration of the loan.
- Is in a highly competitive market and lacks a business plan that shows how the financing will fuel stability and revenue growth, or there is market uncertainty for their industry.
- Needs to sell assets to make money, like inventory being stocked or machinery that will need to be replaced before the financing comes to term.
There are also times where a company may not have to make a personal guarantee to get a financial product including if they have:
- Enough assets to cover the cost of the financing and do not need to use them during the borrowing period.
- A financial history that shows strong cash flow year-round, helping to ensure they can make payments.
- Business bank accounts with the lender, so the lender already knows their financial situation.
- A long-standing history of borrowing that builds predictability and trust.
When a company’s risk as a borrower is high, the likelihood of needing the owner or owners to make a personal guarantee is higher. As a company becomes more creditworthy, their risk as a borrower decreases and the need to make a personal guarantee may be reduced.
When a company is a low-risk borrower, it can begin taking loans and getting credit cards without the owners leveraging personal assets, and that is a huge relief for many business owners.
The Impact on Personal Credit Scores
Personal guarantees will not have an immediate impact on your personal credit score unless the debt is reported to the three consumer credit bureaus, Equifax, Experian, and TransUnion. The only way your personal credit score is impacted is when these three reporting agencies are made aware of debts including missed payments, loans taken out, invoices not paid, etc.
Personal guarantees on business loans, business credit cards, and other forms of credit can impact your personal credit score if the business defaults to the creditor and you made a personal guarantee, as these may be reported to the three bureaus.
Personal guarantees on business financial products are common, so don’t panic if you’re asked to sign one. Looking for a financial institution that meets your unique needs? Let’s connect. We can match you with the best financing for your business in seconds.
SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
