What Is a Personal Guarantee on a Business Loan?
Before you get the funding you need for your small business, you may first have to sign a personal guarantee. Although it’s a common provision within a business loan’s fine print, a personal guarantee can put your personal finances in jeopardy.
What is a personal guarantee?
A personal guarantee is a promise to personally repay a business loan if your company can’t. Lenders add this provision (sometimes spelled “guaranty”) to a business loan agreement when they have concerns over the credit history, age or financial stability of your business, because it can lessen a lender’s risk.
Your business entity also plays a role in how debts are handled.
- Sole proprietorships have the fewest protections — you and your business are legally the same. A sole proprietorship is the most common business type, according to the U.S. Chamber of Commerce.
- Limited liability companies (LLCs) are designed to separate you from your business, but if you sign a personal guarantee on business loans, leases or contracts, you’re promising to pay if your business cannot.
- C corporations or S corporations are separate legal entities, meaning the company is separate from the owner. However, if an owner signs a personal guarantee or contract in their own name, they assume personal responsibility for the debt.
- The type of partnership determines the level of liability. Owners in a general partnership are responsible for business debts, while limited partners and LLP partners typically have liability protection.
Signing a personal guarantee can override the liability protections your business entity would otherwise provide.
Types of personal guarantees
There are two main types of personal guarantees: unlimited and limited. The difference between the two centers on the extent of your liability and how long the guarantee applies.
Unlimited personal guarantees
An unlimited guarantee — also known as an unconditional guarantee — means guarantors are required to pay all amounts due until the note is paid in full. The U.S. Small Business Administration (SBA) may require an unconditional guarantee, or unlimited full guarantee, from owners with a 20% or greater stake in a business applying for an SBA loan.
Limited personal guarantees
A limited personal guarantee, on the other hand, may reduce the dollar amount, time and/or percentage of the loan you’re liable for. An SBA loan’s limited guarantee, for example, includes the following options for when a guarantor is released from liability:
- Balance reduction: When the balance drops below a certain dollar figure
- Principal reduction: When the loan principal drops below a certain dollar figure
- Maximum liability: When a set dollar amount is paid
- Percentage: When a set percentage of the loan plus interest and other costs are paid
- Time: When a maximum amount of time has elapsed
- Collateral: When provided collateral takes the place of a personal guarantee
- Community property or spousal interest: When property owned jointly between spouses or the spouse’s interest in pledged collateral is exempt from enforced collection.
Your lender will determine which one applies to your loan — SBA loans will only have one of the above limitations.
A “bad boy” clause (also called a carve-out) is a conditional trigger that kicks in when a borrower does something illegal or unethical, adding personal liability that wouldn’t otherwise apply.
These are common in commercial real estate contracts, where violations may include fraud, misapplication of funds, unauthorized transfers of the mortgaged property or other collateral and bankruptcy. They give the lender or leasing agency an extra layer of protection.
Personal guarantee: What if I default on the loan?
Signing or agreeing to a personal guarantee may be the only way to get the business loan you need. It gives you an influx of cash, but it comes with several drawbacks.
The main danger is that if your business defaults on the business loan, you are liable for the loan. If a partner or family member co-signs, they could be impacted, too. Some loan agreements pair a personal guarantee with a confession of judgment, which lets the lender obtain a court judgment against you without a standard lawsuit if you default. A personal guarantee can also result in the following consequences:
- Your personal credit declines if you can’t make the payments.
- Your business credit declines if you can’t make the payments.
- You could lose any collateral tied to the guarantee (e.g., equipment, home, car).
- The lender can take your checking or savings balances (including retirement savings) if they were part of the collateral.
In other words, you could go under if your business goes under.
A default under a personal guarantee can show up on both your business and personal credit reports, since the two are tracked separately by different bureaus. Missed payments may hit your business credit file, but once the lender pursues you personally, either through collections or a court judgment, that activity can land on your personal credit report too.
Collections and judgments can stay on your personal credit report for up to seven years, so the damage can follow you long after the business itself has closed.
Alternatives to a personal guarantee
One alternative is a secured business loan, where you pledge a specific asset, like equipment or property, instead of signing a personal guarantee. Because the lender can only collect the pledged asset if you default, a secured loan limits your risk to that one asset rather than your full net worth. It’s generally the better option when you have collateral to offer, since a personal guarantee (or a blanket lien against your business) can expose more of what you own.
If a secured business loan isn’t an option, ask business partners or other owners to co-sign the guarantee, too, so each of you is liable only for a pro rata share. Or ask them to sign a separate agreement to reimburse you if your personal assets are taken to cover the debt. Either approach spreads out your personal liability instead of leaving it all on you. Talk with your legal team to get a realistic sense of what you can bargain for.
Most SBA loans require a personal guarantee, and the threshold is ownership stake. Anyone who owns 20% or more of the business is typically required to sign an unlimited personal guarantee, though lenders can request one from owners below that threshold too.
Owners below 20% may instead be asked to sign a limited personal guarantee, capped at a dollar amount or percentage of the debt. That can include spouses who own 5% or more of the business if their combined household ownership hits 20% or higher.
Guarantors typically have to submit an SBA personal financial statement, which discloses their personal assets, debts and net worth so the lender can assess their ability to repay if the business can’t.
4 ways to reduce the risk of a personal guarantee
If you decide to move ahead with a personal guarantee, make sure you have a plan in place for repaying the loan in full and on time. Study the agreement closely and negotiate what you can before you sign, using these best practices.
1. Negotiate for a limited guarantee
Ask your lender whether a limited guarantee is available before accepting an unlimited one. A limited guarantee caps your liability at a dollar amount, a percentage of the debt or a set time period, so ask specifically what release conditions the lender offers and whether pledging collateral could reduce the size of the guarantee.
2. Ask questions about unclear language
Ambiguous terms leave room for a lender to interpret the agreement in a way that costs you more. If any wording could be interpreted more than one way, ask before you sign, so you and your lender share the same understanding of what you’re agreeing to.
3. Avoid “continuing guarantees”
A “continuing guarantee” stays in effect until it’s revoked, covering not just the loan you’re applying for but future dealings with that lender too. That means you could remain personally liable for past, present and future loans through the same lender, well beyond the original loan’s term. Approach this language with caution and seek the advice of your lawyer.
4. Watch for “joint and several” language
“Joint and several” wording makes you equally as liable as the other business owners signing the loan. Under this clause, the lender can pursue you for the full amount owed, even if your co-owners also signed personal guarantees.
Frequently asked questions
A personal guarantor is the individual who signs a personal guarantee and takes on personal responsibility for a business debt. In most cases, that’s a business owner, but lenders can also ask for a guarantor who isn’t an owner, such as a co-signing family member or business partner. Whoever signs becomes personally liable for the debt if the business can’t pay.
While owners of small businesses and startups are more likely to be asked to sign personal guarantees, there are no set rules. Any business may be asked to sign a personal guarantee, especially if it has a limited credit history or doesn’t have enough value in assets to put up as collateral. Newer businesses and those seeking unsecured financing are the most common candidates, since lenders have less data to judge risk on the business alone.
Some business owners may weigh the risks and benefits of a personal guarantee against a potential cash infusion and decide it’s worth the risk. For others, that risk may be too high to take. Weigh how likely the business is to default, how much personal collateral or savings you’d put on the line and whether a secured loan or a smaller loan amount could get you funding without a guarantee at all.
A personal guarantee may be revoked if the guarantor and lender agree to the revocation in writing, which typically happens when the loan is paid off, refinanced or replaced with sufficient collateral. Debts covered by a personal guarantee can also be discharged in a personal bankruptcy, though the outcome depends on the type of bankruptcy filed and whether the debt qualifies for discharge under the U.S. Bankruptcy Code.
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