What Is a Personal Guarantee?
The term personal guarantee refers to an individual’s legal promise to repay credit issued to a business for which they serve as an executive or partner. Providing a personal guarantee means that if the business becomes unable to repay the debt, the individual assumes personal responsibility for the balance. Personal guarantees provide an extra level of protection to credit issuers who want to make sure they will be repaid.
How Personal Guarantees Work
Personal guarantees are used in credit deals to secure funding for businesses. They are used by new and small businesses—generally, for companies that may not be as established or for those with inadequate credit history to qualify for loans and other credit on their own. When a personal guarantee is given, the principals of the company pledge their own assets and agree to repay a debt from personal capital in case the company defaults. In short, the business owner or principal becomes a cosigner on the credit application.
Here's how it works. Lenders may require business owners or executives to provide a personal guarantee in order to access credit if the company is too new or has a bad credit history. The business principal includes their own credit history and profile as part of the credit application which forms the primary basis for underwriting. When a personal guarantee is used, the applicant includes their Social Security Number (SSN) for a hard credit inquiry as well as details about the individual’s personal income. This information is in addition to the company's employer identification number (EIN) and financial statements.
An executive may also pledge their own personal assets—checking accounts, savings accounts, cars, and real estate—and agree to repay a debt from personal capital in case the company defaults as part of their personal guarantee. Not only does this make credit more accessible to businesses, but it also mitigates the risk to creditors since they have a legal claim to the individual's personal assets. It also improves the terms which will be based on the profile of both the business and the individual in the underwriting process.
Small business owners and executives normally make a substantial initial investment using their own capital. That's one of the reasons why they offer personal guarantees to get credit—because they have a vested interest in the launch and development of their businesses. As such, businesses may be required to pay creditors monthly installment payments rather than generating a return for equity investors.
- 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.
Although well-established businesses with significant commercial credit profiles may be able to obtain credit without a personal guarantee, they may still use them in their applications. Credit with a personal guarantee can be a low-cost way for a business to obtain funds. So if the business isn't able to generate enough revenue and earnings, then an individual could suffer significant losses. Remember, if a personal guarantee is used, the principal is personally liable if a default occurs. It gives creditors a legal right to all of an individual's pledged personal assets.
Having said this, business owners should be especially careful when they apply for credit as terms may require a personal guarantee. Applicants should look for language in the credit application such as “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.”
Many private lenders require personal guarantees before they advance any credit to certain types of businesses. What many people may not realize is that the Small Business Administration (SBA) also requires principals to offer personal guarantees in order to get an SBA loan. Anyone with an interest in a business of 20% or more must provide the SBA with a personal guarantee. These loans are backed by the SBA but are issued by the administration's lending partners.
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 common types of personal guarantees—limited and unlimited. Limited guarantees allow lenders to collect a certain amount of money or a certain percentage of the outstanding balance from a principal or business owner. These guarantees are common when there are multiple principals who can pay a certain portion of the debt. For instance, if a business defaults on its loan, the lender can go after each principal for 25% of the balance.
Unlimited guarantees, however, require that the principal is liable for the full outstanding balance. Personal guarantees required by the SBA are considered unlimited guarantees. So if a business can't fulfill its obligations on a loan with a personal guarantee, the lender can go after the principal to recoup the full outstanding balance. If there aren't enough liquid assets available—through checking and other, similar accounts—the lender can seize other assets like real estate or vehicles.