A personal guarantee is a legal commitment where the borrower guarantees they will be personally responsible for any debts in case of default on a small business loan. Personal guarantees create a personal liability for the debt rather than pledging specific assets as collateral.
It is very common for lenders to require a personal guarantee, including when the borrower is “creditworthy,” meaning they have strong financials and a good business credit score. When the owners of the business are willing to be personally liable, it builds the lender’s confidence in their ability to pay back the loan, and this can increase their chances of getting approved.
There are two types of personal guarantees that can be made:
- Limited personal guarantees allow the lender to seek repayment up to a specified dollar amount or percentage of the money owed.
- Unlimited personal guarantees make the guarantor responsible for all of the loan obligations, meaning the lender can seek repayment until the full amount is recovered (including fees and interest).
While collateral and personal guarantees sound similar, as both can be terms on a loan agreement, they have a few main differences.
The Differences Between Collateral and Personal Guarantees
|
|
Personal Guarantees |
Collateral |
|
Must be owned 100% by the borrower |
N/A |
Yes |
|
The owner of the assets being leveraged |
The individuals that own the business |
The business or LLC itself |
|
Requires a spouse’s signature |
Yes, depending on the state of residence, when the assets are jointly owned or will impact the spouse. |
No |
|
Multiple people must sign |
Only if multiple guarantors are signing the personal guarantee. |
Yes, multiple people will be required to sign if there are multiple owners in the business. |
|
Limited or unlimited |
Can be both |
Unlimited up to the amount of the debt still owed |
|
Is released when the loan is paid off |
Yes |
Yes |
|
Gets filed on UCC liens |
No |
Yes |
In some states, a borrower may be required to obtain a spouse’s signature on a personal guarantee, even if the spouse is not directly involved in the business. This requirement often arises in community property states or in cases where jointly owned assets (such as a home) could be affected by the guarantee.
The goal is to ensure that both spouses acknowledge the potential impact on shared property if the business defaults on the loan. You can learn more about these requirements through your state’s government or legal resources.
In most cases, collateral documents related to business assets will only need the signatures of the business owners, since those assets (not the spouse’s property) secure the loan.
As long as the debt and interest get paid off, collateral will be returned to the owners, and the personal guarantee will not need to be enacted.
Note: If you’re leasing a vehicle for personal or business use and do not own it in full, you cannot use it as an asset for securing the loan.
Personal Guarantees Are Legally Binding
Personal guarantees are legally binding agreements. This means the guarantor becomes personally responsible for repaying the business loan if the business defaults. In such cases, the guarantor’s personal assets may be used to satisfy the debt.
The specific rules and consequences can vary depending on your jurisdiction, the terms of the loan agreement, and your individual circumstances. You should always consult a licensed attorney to understand what applies to your particular situation.
- When you speak with counsel, consider asking about situations such as:
- What happens if one or more guarantors or owners exit the company.
- How personal and company bankruptcies affect the personal guarantee.
- Whether and how the borrower can upgrade or replace assets covered by the loan.
- What to do if the borrower receives an offer to sell the financed asset — even at or above market value.
These situations are common, and your legal counsel can help you understand your options and obligations.
If you plan to exit your company, you’ll typically need to discuss the personal guarantee with both the remaining owners and the lender. A lender is not required to release you from a personal guarantee, but they may agree to modify the arrangement. Possible options can include the business providing additional collateral or the remaining owners increasing their own personal guarantees to replace yours.
If the company goes bankrupt, you may still be personally liable for any obligations you guaranteed, depending on the specific terms of your personal guarantee. If you personally file for bankruptcy, your liability under that guarantee will typically be handled according to the bankruptcy laws and procedures in your jurisdiction. You should consult your legal counsel to understand how these rules apply to your situation.
When it comes to selling, replacing, or upgrading assets, lenders tend to be a bit more flexible when the new asset is worth more or has a higher demand. This makes it easier for them to liquidate in case of default so they can recover their losses with less administrative headaches.
Personal guarantees are normal when a company applies for a small business loan. If your lender asks, don’t worry. They’re simply looking to limit their risk and to confirm your ability to make payments before they lend your business the money.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
