What Is a Personal Guarantee?
Let me explain what a personal guarantee is. It's an individual's legal promise to repay credit that's been issued to a business where they act as an executive or partner. If the business can't repay the debt, you as the individual take on personal responsibility for the balance. This gives credit issuers an extra layer of protection to ensure they'll get their money back.
Key Takeaways
- A personal guarantee is an individual's legal promise to repay credit issued to a business for which they serve as an executive or partner.
- Personal guarantees help businesses get credit when they aren't as established or have an inadequate credit history to qualify on their own.
- Enforcing personal guarantees also mitigates the risk to creditors since they have a legal claim to an individual's assets.
- Business owners should read the terms and conditions of any credit application carefully for language that highlights personal liability.
How Personal Guarantees Work
Personal guarantees come into play in credit deals to secure funding for businesses. They're commonly used by new and small businesses, especially those that aren't well-established or lack a strong credit history to qualify for loans and other credit independently. When you provide a personal guarantee, as a company principal, you're pledging your own assets and agreeing to repay the debt from your personal funds if the company defaults. Essentially, you're becoming a cosigner on the credit application.
Here's the process: Lenders might require you, as a business owner or executive, to give a personal guarantee to access credit if your company is too new or has a poor credit history. You'll include your own credit history and profile in the credit application, which becomes the main basis for underwriting. With a personal guarantee, you provide your Social Security Number (SSN) for a hard credit inquiry, along with details about your personal income. This is on top of the company's employer identification number (EIN) and financial statements.
You might also pledge your personal assets like checking accounts, savings accounts, cars, and real estate, agreeing to use them to repay the debt if the company defaults. This not only makes credit more accessible to your business but also reduces risk for creditors, as they gain a legal claim to your personal assets. It can improve the terms of the credit, based on both the business's and your individual profile during underwriting.
As a small business owner or executive, you often make a big initial investment with your own capital. That's why personal guarantees are offered to get credit—you have a real stake in the business's success and development. Because of this, your business might need to make monthly installment payments to creditors instead of generating returns for equity investors.
Special Considerations
Well-established businesses with strong commercial credit profiles might obtain credit without a personal guarantee, but they could still choose to use one. Credit backed by a personal guarantee can be a low-cost option for funding your business. However, if the business fails to generate sufficient revenue and earnings, you could face significant personal losses. Remember, with a personal guarantee, you're personally liable if a default happens, giving creditors legal rights to all your pledged personal assets.
A report from The New York Times on former President Trump's taxes shows he used this approach, personally guaranteeing loans and debts totaling $421 million by 2018. This had benefits, like allowing the business owner to offset losses against current and future taxes.
That said, be especially careful when applying for credit, as terms often require a personal guarantee. Look for language in the credit application like 'you, as an individual and the authorizing officer of the company...are agreeing to be jointly and severally liable with the company for all charges to the account.'
SBA Loans
Many private lenders demand personal guarantees before extending credit to certain businesses. What you might not know is that the Small Business Administration (SBA) also requires principals to provide personal guarantees for SBA loans. If you have a 20% or more interest in the business, you must give the SBA an unconditional personal guarantee. These loans are backed by the SBA but issued through its lending partners.
Important note: The Small Business Administration requires a personal guarantee from anyone with an interest of 20% or more in a company.
Types of Personal Guarantees
There are two main types of personal guarantees: limited and unlimited. With limited guarantees, lenders can collect a specific amount of money or a percentage of the outstanding balance from you as a principal or business owner. These are typical when multiple principals are involved, each responsible for a portion of the debt. For example, if the business defaults, the lender might pursue each principal for 25% of the balance.
Unlimited guarantees mean you're liable for the entire outstanding balance. Personal guarantees required by the SBA fall into this category as unlimited. If the business can't meet its loan obligations, the lender can go after you to recover the full amount. If liquid assets like checking accounts aren't enough, they can seize other assets such as real estate or vehicles.
Other articles for you
Equity-linked securities are debt instruments offering variable payments tied to equity market benchmarks, serving as an alternative for raising corporate capital.
The Delphi method is a structured forecasting technique that achieves expert consensus through iterative anonymous questionnaires.
This text explains the role, rights, responsibilities, and types of shareholders in a corporation.
Bid size indicates the number of shares investors are willing to buy at a specific price in stock trading.
This text explains what a listed company is, its benefits, listing requirements on major exchanges, and comparisons with unlisted companies.
A European option is an options contract that can only be exercised on its expiration date, differing from American options which allow early exercise.
Currency devaluation is a government strategy to lower a nation's currency value to boost exports and address trade deficits, with both benefits and drawbacks.
Helicopter drop refers to injecting money directly into the economy to stimulate growth and combat deflation.
Landlocked property is real estate inaccessible by public roads except through adjacent lots, often requiring easements for access.
Bond covenants are legal agreements that protect bond issuers and holders by requiring or restricting certain actions.