I regularly receive requests from both small business owners and small business lenders to talk about various issues related to personal guarantees. It is a thorn in the side for each party. Neither is comfortable discussing the issue. In the meantime, personal guarantees continue to be an inherent part of obtaining small business loans.
In this month's column, I discuss the many ambiguities and misunderstandings that surround the topic of personal guarantees, and hopefully supply owners and lenders with the answers they seek.
What is a personal guarantee?
First, a personal guarantee is an unsecured promise from an individual to make loan payments when a small business is not able to do so. Did you notice the word "unsecured"? This is a promise that is not backed up by a specific asset, such as your personal residence, in which case, the asset would be considered collateral.
Why do lenders need it?
This is the question every small business owner wants to hear an answer to, but many lenders are not comfortable spelling out why. The answer is that a personal guarantee is an added assurance that you are serious about your business--and most importantly--serious about repaying the loan.
Here are some key reasons why small business lenders require--and will continue to require--your personal guarantee:
Is a personal guarantee required for all small business loans?
The overwhelming majority of small business loans require personal guarantees from business owners. This is not to say that there aren't lenders who will lend without personal guarantees. Business credit-card loans are the most common example of a business loan without the personal guarantee. The rest will vary from lender to lender, and you will have to do your research to locate lenders who will not ask for or will waive the personal guarantee. Based on my experience in the industry, you will have a greater chance of finding lenders who might be willing to waive the personal guarantee--if your company's financial condition is strong enough to stand on its own. In addition, as your company grows in size and revenue, lenders generally will be less likely to require personal guarantees.
Several recommendations for small business owners faced with signing personal guarantees:
Signing a personal guarantee does come with risks, mainly related to your obligation to repay a business loan and the lender's ability to go after your personal assets if you don't. However, there are benefits. The main benefit is securing a business loan you otherwise might not get.
The key is not to obsess with the issue, but rather focus on limiting the amount of debt and making sure that your company generates sufficient cash flow to make debt payments. A personal guarantee is the reality of life for most small businesses, but it is also a decision that needs to be made with caution.