Business owners often encounter the term “personal guarantee” when seeking business loans. But what does it actually mean, and how does it differ from collateral? Understanding these terms and how they can affect you is crucial for any business seeking funding. Even more importantly, knowing what steps to take if insolvency strikes can help you weather the storms that sometimes accompany entrepreneurship.
What is a Personal Guarantee?
When you take out a small business loan, lenders want to ensure they get their money back, even if the business fails. Owners are often asked to give a personal guarantee to the lender as security, making them personally liable for the debt if the business cannot pay.
A personal guarantee allows the lender to seize assets and/or cash from the individual business owners up to the amount specified in the guarantee agreement. Collateral, on the other hand, gives the bank a specific asset or part of the business to seize—like machinery, commercial real estate, company vehicles, inventory or accounts receivable—if the business defaults on the loan.
If you own a house, you’ll likely want to know if it would be considered collateral or part of a personal guarantee. The answer is both—collateral assets and the things pledged as part of a personal guarantee can be one and the same, but the process by which the bank pursues and acquires them is different.
Types of Personal Guarantees
There are different types of personal guarantees. An “unlimited/unconditional” guarantee means the borrower is responsible for repaying the entire loan amount, regardless of their circumstances. In the case of SBA loans, for instance, business owners who own 20 percent or more of the company must sign an unconditional guarantee.
A “limited” personal guarantee, however, is just what it sounds like—the borrower’s responsibility is capped at a certain percentage or amount of the loan. Looking back at our SBA loan example, business owners who own less than 20 percent of the company may sign a limited guarantee.
“Joint and several” is a third type of personal guarantee that means multiple individuals guarantee the loan, and each can be held responsible for repaying the full amount.
Why Agree to a Personal Guarantee?
If your company can provide security (another word for collateral) on the loan, you may not need to assume personal liability for the debt. However, when a business lacks sufficient collateral or has a limited credit history, a personal guarantee is a way to access otherwise unattainable funding.
Alternative lenders often don’t have collateral requirements, making capital easier to qualify for and misleading business owners into thinking there is less on the line. This can be a dangerous miscalculation.
If you find yourself in a position where your business requires capital that cannot be acquired without a personal guarantee, here are several factors to consider before signing on the dotted line.
- If you must cover the debt using your personal assets and cannot, your credit rating may suffer, and you may even be forced to file for bankruptcy.
- Personal guarantees can often be subject to immediate repayment if demanded by the creditor—and this will likely be at the creditor’s sole discretion.
- Sometimes, personal guarantees include an “indemnity”—an agreement that the debtor will pay for any losses suffered by the creditor. Naturally, providing an indemnity is best avoided wherever possible.
- The bank can sell personal assets used to secure the guarantee without needing to go to court. This may include—and is not limited to—your home.
- Careful attention should be given to provisions in the guarantee that may also put you personally on the hook for future debts and accrued interest.
Before Signing a Personal Guarantee, Make Sure You Understand the Following:
- What exactly is considered a default?
- How will the creditors enforce the guarantee?
- In the case of default, will the lender file a lawsuit or send a collection notice?
- Is there a remedy period, meaning a specified period of time to pay the default balance?
- Are the circumstances of your personal finances or assets likely to change after signing this guarantee?
- Is there any provision in the guarantee requiring the creditor to make personal demands on you only as a last resort?
Steps to Take if You Can’t Make Your Loan Payments
Insolvency can be a stressful experience, especially when personal assets are at risk. Here are steps to help you navigate this challenging situation:
Assess Your Financials: Take a comprehensive look at your business and personal finances. Identify all debts, assets and liabilities to understand the full scope of your situation.
Communicate with Your Lender: Early and transparent communication with your lender is critical. Explain your situation and express your desire to do right by them. Reputable lenders may be willing to explore possible solutions, such as loan restructuring, payment deferrals or temporary relief.
Sell Non-Essential Assets: Liquidating non-essential assets can generate funds to repay debts. This step also demonstrates to lenders that you are taking proactive measures to address the debt.
Consult a Personal Guarantee Resolution Specialist: The rest of the steps on this list can be performed by you as the business owner, but are unlikely to be as effective as if they are undertaken by a firm that specializes in debt restructuring and personal guarantee resolution.
Negotiate with Your Lender: Sometimes, creditors are willing to negotiate a settlement for less than the owed amount. Rise Alliance, together with its parent company, Second Wind Consultants, has successfully negotiated settlements like these for distressed businesses for more than a decade.
Explore Alternatives to Bankruptcy: With the help of a reputable personal guarantee resolution firm, liquidation and bankruptcy can be avoided. This preserves economic value, owners and jobs and provides wins for all parties.
Create a Strategy: Navigating the complex financial landscape with the help of an expert can provide insights and help you understand your options. While financial advisors and CPAs understand the broad strokes of what’s available, Rise Alliance has the experience and the network to tailor a solution for your business that’s exactly what your business needs.
Plan for the Future: Develop a long-term financial plan to rebuild your credit and avoid future financial pitfalls. This plan should include a comprehensive financial strategy that maximizes cash flow and provides a clear picture of current and future expenses, helping you to make good on your personal guarantees.
Rise Alliance provides access to an affordable business financial planning platform, which allows clients to work with professional accountants & financial planners who can help design a road map for achieving financial freedom. Once their balance sheet has been resurrected, we also help our clients secure conventional funding by introducing them to our funding partners.
A personal guarantee on a business loan is a significant commitment that ties your personal financial health to your business’s success. Understanding your personal guarantee and the steps to take if you face insolvency can help you manage risks effectively. If your business is in distress and your personally-guaranteed assets are in jeopardy, schedule a free consultation with one of our consultants today.
