If you own a small business and have ever borrowed for it, you almost certainly signed a personal guarantee. When sales are slipping and the payments are getting harder to make, those personal guarantees loom very large. Fall far enough behind, and putting your personal home at risk isn’t hypothetical anymore.
A personal guarantee is just what it sounds like: you promise your lender that if your company can’t pay the loan, you will. You’re taking on personal responsibility for the debt. With risk tight, banks want as much protection as possible. That means most small and midsize business owners will have to sign a personal guarantee in order to get a loan. Think of it as a signed blank check that never expires. And although defaulting on a business loan is painful enough, with a personal guarantee, defaulting can cost you your house as well as your business. The guarantee often reaches a spouse’s assets too. Few owners sign one lightly, and they shouldn’t: when you do make that final signature, you’re taking on one of the biggest debts and liabilities you’ve ever signed.
Credit Loss Protection
The risk of businesses failing has been the no man’s land for insurance companies. With the exception of trade-credit insurance and some limited credit-enhancement insurance, you, the owner, bear the risk that your business will fail. In new developments, however, insurers are starting to analyze and price the risks of business failure, and some are now providing credit loss protection - specifically to business owners who have a personal guarantee on a business loan. Given the breadth of risk and the potential severity, insurance is a natural fit here. The product is called personal guarantee insurance, or PGI.
Think about how much effort goes into protecting an owner’s assets. Lawyers set up corporations, LLCs and trusts, and brokers line up liability and property coverage. Then the bank asks for a guarantee, and all that protection goes out the window. If the business doesn’t succeed, the risk balance is the owner’s to take on personally.
PGI is meant to put that wall back up. It indemnifies a portion of the guarantor’s obligation should the guarantee be called. That portion can be substantial: policies can be designed to pay up to 70 percent of a deficiency judgment after a loan default. PGI doesn’t replace a business owner’s duty to pay the debt, though. Even with the maximum, the guarantor still has to pick up any remaining balance, which means at least 30 percent of any deficiency is still yours.
The bank gets something out of the arrangement too. For one, the insurance proceeds from this policy could be assigned to the lender in order to give the lender improved collateral position on the loan. In doing so, the lender would then have both the customer’s business as collateral and a signed personal guarantee, now backed by insurance. The coverage does improve the bank’s position, and that can lead to a lower rate that might offset the cost of the insurance. So if PGI is priced appropriately, the arrangement benefits both the customer and the bank.
The catch is timing. PGI is typically issued within six months of a loan’s origination or a material modification of it, and it is based on the same information that was used to approve the loan. For an owner who is already behind on payments, that’s too little, too late. PGI is not the solution. It’s an arrangement that needs to be planned for in advance. Either way, you need to talk to a broker.
So is personal guarantee insurance worth it? It adds an extra expense to the loan process but offers peace of mind, just in case something happens and the lender has to look to your personal assets. In the end, for the customer the key question is: How valuable is the protection to me? For an owner signing a new loan, the case is strong: the risks of failure are mitigated if the guarantor does not have to fully assume the cost of the deficiency judgment. It’s one more brick in the wall, keeping your assets out of the reach of a debt a business can’t service. It is not magic, so it doesn’t erase your debt obligation, and you should start thinking about PGI a long time before you need it. This is a new product, so it’s far from a perfect fit for every situation. Bottom line: the cost of PGI versus the potential savings or relief it provides can vary and depends entirely on circumstances.
Your Loan Is Already in Trouble
But if your loan is already in trouble, a policy you can no longer buy won’t save you. What may have been right for you yesterday is going to be useless today. Fortunately there are reasonable options you can consider. Ask yourself if you are still meeting the payment obligations on your commercial debt and if you are unable to do so then what will you do. Will you have other financing available to you? Or will you default on your debt? You may think you’re the one out of options, but your bank is under the gun too. Your biggest asset here is your knowledge and initiative in sorting through the situation and pushing back. Be realistic, though: your company’s operating cash flow must be sufficient to service the new debt obligation you are negotiating. If it is not, a restructured loan will prove to be a temporary cure and not a fix. Ultimately, you should talk to a professional that can evaluate your individual situation and make recommendations.
Raise PGI Before the Loan Closes
And if the business comes through this and you are asked to sign another guarantee someday, imagine being able to tell the lender, “Look, here’s my wall. Here are my insurers. There’s my protection.” Put the guarantee on your review list alongside employment practices, environmental and cyber exposures, and raise PGI before the loan closes. Each situation requires a careful analysis to determine the value that PGI can provide. Get the timing right, and thanks to PGI you may finally sleep a little better too.
