What is a Personal Guarantee?
A personal guarantee signifies an individual’s legal vow to repay credit allocated to a business for which they are an executive or partner. Committing to a personal guarantee indicates that if the business fails to repay the owed amount, the individual takes on personal responsibility for the debt. For lenders, personal guarantees offer an additional layer of protection to assure repayment.
Key Highlights
- A personal guarantee binds an individual to repay credit assigned to a business where they hold a key position.
- It helps less-established businesses or those with insufficient credit history to secure financing.
- Creditors benefit from personal guarantees as they reduce lending risk by claiming an individual’s assets if the business defaults.
- Business owners should pay attention to credit terms to understand personal liability clearly.
How Personal Guarantees Work
Personal guarantees are instrumental in procuring funding for businesses, especially new and small enterprises without a solid credit history. When committing to a personal guarantee, business principals agree to cover the debt from their own assets if the business cannot fulfill its obligations. Essentially, the business owner or principal acts as a cosigner on the credit application.
Here’s a breakdown of the process:
To access credit, lenders might request business owners to provide a personal guarantee if the company is nascent or holds a weak credit profile. In this scenario, the principal must submit their personal credit history and detailed financial data, which will be a significant factor during the underwriting process. A hard credit inquiry, personal income details, and company financial statements are pivotal components of this application.
An executive might also pledge personal assets such as bank accounts, vehicles, and real estate. This not only heightens credit accessibility but also reduces lender risk by legally linking personal assets to the business debt. This method can also enhance credit terms based on the combined profile of the individual and the business during the underwriting process.
Small business leaders typically make substantial investments through their capital, driving their motive to offer personal guarantees. As they seek credit for business growth, they ensure a profit return for themselves, bypassing the need for equity investors.
Important Considerations
While established businesses with a strong commercial credit profile might secure credit without a personal guarantee, utilizing one can still be advantageous for cost-effective financing. However, if the business fails to generate sufficient revenue, the involved individual stands a risk of notable financial loss, as signed personal guarantees grant creditors a legal claim to pledged personal assets.
For instance, a New York Times report revealed that former President Trump had personally guaranteed loans and debts amounting to $421 million by 2018. Such actions, aside from welcoming additional fiscal responsibility, could also offer tax benefits by offsetting losses against current and future taxes.
Businesses aiming for credit should meticulously seek any mention of personal liability. It’s crucial to identify terms within the credit application indicating joint responsibility for all charges extended to the account.
SBA Loans
Many private and public lenders necessitate personal guarantees to extend credit. The Small Business Administration (SBA) also mandates personal guarantees for SBA loans. Partners with a 20% or greater ownership stake in a business need to provide these guarantees, committing unconditionally if seeking SBA-backed loans, despite these loans’ extension by the administration’s lending affiliates.
Types of Personal Guarantees
Two common forms of personal guarantees are limited and unlimited guarantees. Limited guarantees authorize lenders to retrieve a specified sum or a certain percentage of the outstanding debt from each principal, commonly observed in scenarios with multiple principals each backing a portion of the debt.
Conversely, unlimited guarantees render the principal accountable for the entire debt. The personal guarantees demanded by the SBA are typically unlimited. Therefore, if a business defaults on a loan, the lender can pursue the entire outstanding balance from the principal. If liquid assets are insufficient, creditors might seize other properties, including real estate or vehicles.
Related Terms: Credit, Debt, Small Business, Credit History, Assets, Risk, Revenue, Liability.
References
- New York Times. “Long-Concealed Records Show Trump’s Chronic Losses and Years of Tax Avoidance”.
- SBA. “Unconditional Guarantee”.
