Do I Need a Personal Guarantee for a Business Loan?
In these tough financial times, a personal guarantee is almost always necessary for a business loan, especially for start-up loans.
What is a personal guarantee?
A personal guarantee is simply an agreement you sign agreeing to pay back the loan personally if the business cannot pay. It's like you are the co-signer on the loan. This agreement is binding even if your business is not connected to you personally, like a corporation or limited liability company (LLC). If the corporation fails, for example, and cannot pay its bills, your personal guarantee can be activated by the lender.
A personal guarantee may be required from the business owner even if the business is a separate legal entity, like a corporation or LLC.
A personal guarantee may be secured by personal assets, like the owner's home equity, or it may be unsecured, based only on the good faith assurances of the borrower. The guarantee requires the borrower to promise to make good on the loan, even if the business cannot repay
Why is a personal guarantee necessary?
Starting a small business is a risky proposition, and a small business start-up loan is the riskiest loan a bank can give. Even if you can get an SBA loan guarantee, you will most likely still be required to sign a personal guarantee. The Small Business Administration (SBA) says, "All owners of 20% or more of [a] business are asked to provide a personal guarantee in order to obtain an SBA guaranteed loan."
Even if you don't use an SBA loan guarantee, most bankers will still require you to have a personal guarantee for your start-up loan. The bank wants you to have a financial stake in the success of the business and they want you to understand you can't just walk away from the business if it fails and leave the bank holding the bag.
What if I don't have assets to pledge?
Even if you don't have assets, you may be required to sign an unsecured personal guarantee document. If you do have assets, like equity in a home, you will probably have to pledge them and agree to use them to pay back the loan if your business cannot pay it. If you find a co-signer, this person must be prepared to pledge assets against the loan. Aunt Minnie in the nursing home with no assets is not going to be acceptable as a co-signer.
In other words, if you want a start-up business loan, you probably don't yet have any business collateral to pledge, so you are almost certainly going to have to have (a) cash, from 20 percent to 50 percent of the loan value, and (b) personal assets which you assign to the bank in the event of a default on the loan. If you have neither of these things, there is a good chance you will not get the loan. If you do get the bank to agree to the loan, count on being required to provide a personal guarantee.
Can I still get protection from liability?
You may be able to benefit from setting up your business as a limited liability company (LLC) or S corporation; one of these entities might still be of benefit in protecting other assets from being consumed by the business's liability. But don't expect to hide behind a business structure when it comes to paying off your bank loan if you have signed that personal guarantee. Check with your tax and financial advisers before making a decision about business type.