Getting approved for a term loan can be difficult if your company has poor credit ratings. If this is the case, a business lender might look at your personal assets to help secure the loan. If your business has a poor track record in repaying debt and borrowing, many financial institutions will require that you sign a personal guarantee.
However, it can increase your chances of being approved for a loan. It would help if you did not rush to sign a personal guarantee without fully understanding it.
We’ll show you how to get an unsecured loan for your business and explain why a personal guarantee might be a good option.
What you need to know about personal guarantees on business loans:
What is a Personal Guarantee?
Personal guarantees are written promises to repay business loans with personal assets if your company cannot pay its debts. The guarantee can be secured or unsecured. This means that the lender may require you to pledge certain assets.
If your business fails, the lender may pursue your finances, real property, and other assets.
Why do Lenders Need a Personal Guarantee?
Lenders require a way to evaluate your ability to repay a loan. Many small businesses don’t have the required credit history. Surprisingly, Manta’s survey found that 72% of small-business owners don’t know their credit score. Many business lenders will use your credit score as a proxy for the creditworthiness of your business.
What are the Benefits of a Personal Warranty?
A personal guarantee can increase your chances of getting approved for a loan. The personal guarantee also indicates to the lender or bank that you are willing to risk your assets for the benefit of your business.
Lenders may be reluctant to provide business financing without personal guarantees, as over 20% of small-sized businesses fail within the first year. You and your business partners should be willing to take on the risk so potential lenders will also consider your business.
What are the risks associated with personal guarantees?
Personal guarantees carry the risk that your business may fail to pay its debts. If this happens, you will be responsible for repaying the loan using personal assets.
You could lose your home, personal savings or other collateral depending on the loan’s size. It is important not to pledge more than what you can afford to lose.
The lender may take legal action against you if you cannot repay the loan in full with your assets. Negative judgments can cause credit damage, making it more difficult for you to borrow money in the future. Equifax reports that negative information stays on your credit report for seven years.
You may be responsible for your share of the debt if you sign a joint and several liability agreements with business partners. The agreement allows the lender to collect the loan amount from all or any party, depending on who has enough funds. If your partners fall short, you may be responsible for repaying the loan amount.
Don’t forget your guarantee if your business is sold while you have a loan balance. You can still be held responsible if the new owner does not pay the loan balance if you forget.
Who should sign a personal guarantee?
The rule of thumb is that any person who owns less than 20% equity in a business should personally guarantee its loans. You are responsible for signing the personal guarantee if you are the primary business owner.
If you are married, your spouse must also sign the personal guarantee. Lenders will require your signature to transfer joint assets to your spouse. This protects you from any risk.