Personal guarantees require business owners to take personal responsibility for business loans.
Business loans are inherently risky for lenders due to the low survival rates of small businesses. According to the U.S. Small Business Administration (SBA), only about half of small businesses make it to the five-year mark, and around a third survive a decade. To reduce the risk of unpaid defaults, business lenders often require personal guarantees from business owners. But what exactly is a personal guarantee and should you agree to one? Here’s what you should know.
What is a personal guarantee?
A personal guarantee refers to a provision in a loan contract that requires an individual (also known as the guarantor) to pay for a debt if the primary borrower defaults. For example, suppose you take out a $25,000 loan for your business and agree to a personal guarantee. If your business goes bankrupt but still owes $15,000 on the loan, you would be personally responsible for repaying the outstanding balance.
How does a personal guarantee work on a business loan?
When business lenders require personal guarantees, the application process involves a review of both the business and the business owner. For example, you’ll often have to provide your Employer Identification Number (EIN) and Social Security Number (SSN), your business revenue and personal income, and your business and personal credit information. The lender then reviews everything to determine if you qualify.
If you get approved and make all your payments on time, you won’t be impacted by a personal guarantee. However, if your business can’t make the payments and the loan goes into default, the responsibility will fall onto you. If you can’t repay the loan, the lender can send your account to collections. Additionally, they can sue you in an attempt to win a judgment that allows them to seize your assets, such as your bank accounts, investment accounts, or physical property.
Limited vs. unlimited personal guarantees
While all personal guarantees require individuals to take responsibility for loans, the liability can be limited or unlimited. An unlimited personal guarantee makes the guarantor liable for all of the costs associated with a loan, such as the principal amount, interest, fees, and enforcement expenses (when applicable). On the other hand, limited personal guarantees limit the guarantor’s liability. For example, the SBA gives lenders the following guarantee limitation options:
- Minimum total balance: The personal guarantee is canceled once the total balance drops below a certain amount.
- Minimum principal balance: The personal guarantee is canceled once the principal loan balance drops below a certain amount.
- Maximum liability amount: The personal guarantee is limited to a certain dollar amount.
- Maximum liability percentage: The personal guarantee is limited to a certain percentage of the total costs.
- Collateral: The personal guarantee is limited by the value of a borrower’s pledged collateral.
Be sure to carefully review the personal guarantee clause in your contract to ensure you understand how far your liability extends. All things equal, a loan with a limited personal guarantee would be advantageous over one with an unlimited guarantee.
What credit scores are required for business loans with personal guarantees?
When business loan lenders require personal guarantees, they often require guarantors to meet certain credit score requirements. However, they vary by lender. For example, OnDeck requires a minimum personal FICO score of 625, Fundbox requires at least 600, and Bank of America requires at least 700. You’ll want to check your credit scores and the requirements of lenders when deciding where to apply.
Do all business loans require personal guarantees?
All business loan lenders don’t require personal guarantees on all their loans. However, many do, especially on unsecured loans and credit lines. For example, the SBA requires them on SBA loans, as do popular business lenders like OnDeck, Fundbox, and Bank of America.
If you’re looking for a loan that doesn’t require a personal guarantee, you’ll likely have the best luck with secured credit products like invoice financing, merchant cash advances, and loans backed by physical property. The presence of collateral allows lenders to recover their losses in the event of a default which reduces the need for a personal guarantee. Here are a few examples:
- PayPal Working Capital: PayPal offers customers working capital loans and doesn’t require a credit check or personal guarantee. If you qualify, you can borrow an amount and pay it back over time through a percentage of your sales.
- Ramp Flex: Ramp offers working capital loans and doesn’t require a personal credit check or personal guarantee. It allows you to delay vendor payments by a period, such as 30 to 90 days.
- Commercial Real Estate Finance Company of America (CREFCOA): CREFCOA offers non-recourse commercial real estate loans for loan amounts above $2 million.
Additionally, if you don’t want to be personally liable for a business loan, you’ll need to incorporate your business or set up a Limited Liability Company (LLC). From there, be sure to keep your business and personal finances separate to avoid “piercing the corporate veil” which can negate your liability protection.
Pros and cons of personal guarantees on business loans
Personal guarantees on business loans can be helpful, but they also come with risks. Here are the main pros and cons to consider.
Pros
- Strengthens your application: Providing a personal guarantee can help you get a business loan when your business can’t qualify on its own.
- No impact if the loan is paid: If your business pays the loan as agreed, your personal credit and finances won’t be impacted.
- Improve loan terms: Good personal credit can help you qualify for better rates and terms on business loans.
- Widely available: Business loans with personal guarantees are easy to find.
Cons
- Minimum credit score requirements: Lenders require that you meet certain personal credit score requirements to qualify.
- Personal financial risk: If the business goes bankrupt before the loan is repaid, you will be personally responsible for the outstanding loan balance.
- Personal credit risk: If the loan goes into default, it can impact your personal credit score.
- Legal ramifications: If you can’t pay the amount, the lender can sue you and win the right to seize your personal assets.
Should you get a business loan with a personal guarantee?
Getting a business loan with a personal guarantee can be a good option, but it’s important to understand the implications. On the upside, it can help you qualify for business financing and get better rates. Further, the loan application process can often be completed online within a matter of minutes because the lender won’t need to appraise any collateral.
On the downside, if your business defaults on the loan, you’ll be liable so need to ensure you’re prepared to pay the amount or deal with the consequences. It can also be difficult to get a business loan with a personal guarantee if your credit is in bad shape. If you’re having trouble qualifying, you may have better luck with a secured loan option.
Frequently asked questions
Do SBA 7(a) loans require a personal guarantee?
SBA 7(a) loans typically require an unlimited personal guarantee from individuals who own 20% or more of a business. While the SBA may pay the lender in the case of a default, the borrower will still be responsible for the amount.
Are you personally liable for a business loan?
If you take out a business loan and agree to a personal guarantee, you’ll be personally liable if the business defaults. You’ll also be liable if your business is structured as a sole proprietorship, general partnership, or limited partnership.
What happens if you can’t pay a personal guarantee?
If you can’t pay a loan amount you guaranteed, the creditor can make continued collection attempts and has a period in which they can sue you. If they file a lawsuit and win a judgment, they can gain the right to seize and sell your assets to recover the amount.
