How a personal guarantee on a business loan works

Discover what you should know before you personally back a business loan.

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If you’ve spent some time searching for a business loan, chances are you’ve come across more than one that asks for a personal guarantee from the owner or owners. It’s a common feature of small business financing, especially if your business just barely makes a lender’s requirements for revenue and years trading.

We break down what it means, how it can help and when you might want to consider other options that don’t put your family’s finances on the line.

What is a personal guarantee?

When you sign a personal guarantee on a business loan, it means that you’re on the hook for paying off all or part of your business’s debts if your business can’t. Personal guarantees are usually unsecured, meaning that they aren’t tied to a specific personal asset like your home or your car – you’re just responsible for paying up by whatever means. Many small business lenders require a personal guarantee because small businesses can be risky to lend to.

A personal guarantee often increases your business’s chances of being accepted for a loan and can give you access to better rates, but also comes at a huge personal risk – if your business is unable to repay the loan, you might compromise your savings or even end up with a personal bankruptcy that will stay on your credit report and thus impact your chances of getting credit for six years.

So, you need to consider your options carefully before signing up for it. Most importantly, you need to know what you’re signing – if you’re not sure what the contract you’ve been sent entails, it may be a good time to seek out legal advice.

Personal guarantee vs indemnity

You may be asked to act as a guarantor or as an indemnifier, and it’s important to understand which the case is because if things were to go wrong you’d be liable in different ways:

  • Personal guarantee. A personal guarantee creates a so-called “secondary obligation”. This basically means that the creditor will go to the company first and will only come to you if the company is unable to repay its debt. A personal guarantee is often capped to an agreed amount, but the guarantor is always liable if the company fails to repay the loan, no matter the reason.
  • Indemnity. An indemnity creates a “primary obligation” to compensate a lender for its losses if the company doesn’t pay the loan back and is also in breach of certain conditions that are established by the contract (for example, if the shortfall is due to fraud). An indemnity is usually unlimited, but the liability only applies in the specific cases set out in the contract.

In both cases, checking the contract carefully is obviously pivotal to understanding what the consequences of taking out a guarantee may be.

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What can I do to lessen the risk?

Given that personal guarantees are such a common practice, if you can’t avoid giving one, it may be worth knowing how you can minimise its impact on your personal finances:

  • Negotiate the cap. First of all, make sure that the personal guarantee is limited to a certain agreed amount, and secondly, see if you can negotiate it.
  • Consider personal guarantee insurance. It is obviously an extra cost, but it may give you some extra peace of mind, especially if your business’s future looks uncertain. The cost will depend on the amount of the guarantee, and the policy will usually cover only a percentage of it anyway, so you should weigh the pros and cons carefully.

Pros and cons of a loan with a personal guarantee

Pros

  • Increases chances of approval. A personal guarantee takes some of the risk off your lender’s shoulders, making them more willing to work with your business.
  • Can help you get competitive rates. The most competitive rates on a business loan generally go to the lowest-risk clients.
  • Not tied to specific collateral. Personal guarantees offer more flexibility than a secured loan since you don’t have to put any specific assets on the line.

Cons

  • It’s a personal risk. Losing your business is already a personal financial hit. A personal guarantee could require you to pay off a loan at the worst possible time.
  • Can be hard to get out of. This can be an issue if you sell your business in the future – you’ll still be on the hook if that business fails if you don’t change your contract.
  • Your personal finances count more. Lenders often pay closer attention to business owners’ personal assets and creditworthiness when a personal guarantee is on the table, meaning that you could have trouble getting approved if you have poor credit.

What if I don’t have a lot of personal assets?

Since a personal guarantee doesn’t require any fixed assets – like your apartment or family heirlooms – you don’t necessarily need to have any to personally guarantee a loan. However, you typically need to have some sort of funds to show you’ll be able to pay off the loan. You’ll also need to meet certain credit score criteria to get approved for a personal guarantee. In some cases, you might be required to submit a list of all your assets and liabilities during the application process – even if it isn’t much.

Alternatives that don’t involve a personal guarantee

There’s no way around it: personal guarantees are a huge risk that can affect you and your family. Here are some other options you might want to consider instead of taking on that responsibility.

  • Secured loans. Instead of putting your personal property on the line, consider using your business’s assets for a secured loan instead. If your business can’t pay off the loan, your lender will come in and take the collateral. There’s no risk of suddenly becoming homeless or losing your savings. Many property, equipment and business vehicle loans are secured with the property, equipment or vehicle your business buys.
  • Specialist lenders. Some lenders do offer small business loans without a personal guarantee, so it’s worth checking them out. However, you’re likely to be offered a higher rate.
  • Alternatives to a loan. A loan isn’t the only way a business can be financed. You could also consider talking to your investors to see if you can get more funds, starting a crowdfunding campaign or applying for a government scheme. Learn more about government support for businesses.

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