If your business has an SBA loan, you almost certainly signed a personal guarantee. A personal guarantee is just what it sounds like—a promise. You promise to pay what the business owes if the business can’t pay it. Even if the debt is in your company’s name, a personal guarantee places responsibility for the debt onto your personal assets. A personal guarantee makes you legally responsible for repaying the business’ loan. If your business defaults on the loan, you will personally owe the money. Think of it like co-signing a car loan for a friend: if they stop paying, the payments become yours.
Why does the lender want it? Every business loan carries the risk that the lender won’t get repaid in full. No one likes personal guarantees. You don’t want to put personal assets on the line for a business loan. But the business might not be strong enough on its own. The lender might not trust the business because it doesn’t have a big enough track record or solid collateral. The lender can’t always predict how the business might do in the future. But the lender might want to make the loan anyway. The only way they will trust you enough to make the loan is if you put your neck on the line for it. That is where the personal guarantee comes in. Generally, lenders require a personal guarantee if the company receiving the loan doesn’t have a satisfactory credit rating. Loan guarantees are also common for new businesses. Lenders know most new businesses are risky. They require a personal guarantee to shift some of that risk onto the business owners. With SBA loans, anyone who owns 20% or more of the business is typically asked to sign.
A limited personal guarantee would set a maximum amount that you can be forced to pay if you default on the business loan. An unlimited personal guarantee is a guarantee that does not set a maximum amount. SBA loans usually call for the unlimited kind. Most personal guarantees are for the full amount. Usually, you’re liable to pay every penny. That means the full balance plus interest and fees, and if you have partners, each of you can be liable for the entire loan, not just your share of it.
Your Personal Assets
If you’re already behind on payments, this is where it gets real. The lender can go after your personal assets, like your home or your car. They can try to make you pay the loan out of your personal bank account. When you default on a loan, a lender can try to enforce the guarantee. They can come after you personally to cover the debt. You could have to pay cash, make arrangements to pay, or turn over assets. And it might not be pretty. Even if the business has no assets, the lender can still come after you personally. A default may show up on your personal credit reports, and the bureau is going to hold that on your record for up to seven years. Some lenders want both spouses to be guarantors. If your spouse signed the personal guarantee, they’re on the hook for repayment of the loan and have their personal assets at risk, too.
Many owners assume their LLC protects them. It doesn’t. The personal guarantee and the liability protection of an LLC are two different things. The personal guarantee is, well, personal. Personal means it applies to you, and it gets attached to you no matter what business structure you’re using. A lender can make a loan to an LLC without one, but if the lender wants a personal guarantee on a loan, they are going to get it from the Member of the LLC. The best way to think about the personal guarantee is that it is a credit decision. And if you run the business as a sole proprietor, there is no shield at all. A sole proprietorship is a business that has no legal separation between the business and the owner.
Find the Paperwork
So what should you do? First, go find the paperwork. And read it. Until you know what you agreed to, you’re flying blind. Make sure you understand exactly what you signed. Find out whether you have a limited or unlimited guarantee. Carefully review the loan agreement. It should spell out which assets are pledged and under what conditions the lender may try to collect from them. It might be a few pages long, but don’t leave anything to chance. If you can’t find the paperwork, reach out to the lender. Ask for the guarantee document and read it carefully.
Talk to your partner or partners. Sit down and have the conversation, making sure they’re clear on everything. If several of you signed, decide now who handles repayment if the business defaults. Whatever you agree among yourselves, remember: The LLC agreement is a contract between the members of the LLC, not a contract with the lender. The loan agreement is what dictates what the lender can and cannot do to collect.
Signing a new guarantee? First make sure the payments won’t strain your operating budget. You may be able to negotiate. Negotiate on the amount guaranteed. Negotiate on how long it lasts. The guarantor may be able to shorten the date on the personal guarantee so that it ends on a specific date. And ask whether your spouse can be removed from the agreement. If your business credit and other qualifications are strong, a manager may even agree to waive the requirement. To minimize risk, study the details of any business loan, and do so before signing it. Talk to an attorney who knows loan agreements. An experienced business attorney can help you understand the legal implications and exactly what you’re agreeing to.
Double-Edged Sword
While personal guarantees are scary, they are often a necessary step in the world of business loans. Lenders need to lower their risk. In the end, a personal guarantee is a double-edged sword. It can be a path to a business’s success, allowing you to secure funding that you might otherwise not qualify for. But it can also lead to personal financial ruin if you can’t fulfill the obligation. That said, taking on personal liability isn’t a choice you should make lightly.
If your business is struggling and you signed one, take the time to think things through and evaluate what’s really at risk. Don’t sit tight and hope the business continues to thrive. If it does, great. If it does not, you may regret waiting too long to act.
