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Looking for a loan for your business? You’ve likely come across lenders requesting your social security number so they can run a personal credit check. But why do they want your personal information for a business loan? In short, they require a personal guarantee.
Personal guarantees are pretty common in business lending as they help to reduce a lender’s risk. They can also help you get a loan if you don’t have business credit yet. That said, there are some risks involved for you. Here’s what you should know about agreeing to a personal guarantee on a business loan.
Want to skip ahead? Jump-to:
- What a personal guarantee is
- How personal guarantees work
- The types of personal guarantees
- Business funding that requires personal guarantees
- The pros and cons of personal guarantees
- Should you avoid a personal guarantee?
- Alternatives: Business funding that doesn’t require personal guarantees
What is a Personal Guarantee?
A personal guarantee, or PG, is a legally binding agreement stating that you (the guarantor) will be responsible for repaying a debt that’s issued to a business you own.
In many cases, not including sole proprietorships and general partnerships, businesses are established as entities separate from their owners. Being so, the business’s debts belong to the business — not the owners.
A personal guarantee connects an owner to a business debt so that they are responsible for repaying it if the business can’t.
How Does a Personal Guarantee Work?
When a lender requires a personal guarantee, you (as the business owner) will need to undergo a personal credit check. The lender will analyze your credit report and FICO scores to determine your creditworthiness. The amount of risk you present will determine whether your business gets approved for business credit or not, and the interest rates and fees you’ll get.
If you get approved, your business can then receive a loan and will be required to repay it according to specific terms and conditions. In the case that your business can’t make the payments, the lender will look to you. If you don’t make them, you will be personally responsible which means you can face collection attempts, derogatory marks on your credit reports, and even lawsuits. On the other hand, if the debt is paid as agreed by your business, the personal guarantee will never come into play.
Types of Personal Guarantees
When looking into personal guarantees, there are two main types — limited and unlimited.
Limited Personal Guarantee
A limited personal guarantee means that your liability for the debt is limited in some way. For example, if two owners guarantee the loan, each owner could be personally responsible for just 50% of the balance owed.
Unlimited Personal Guarantee
An unlimited personal guarantee means that you are fully responsible for guaranteeing the loan amount and any associated interest and fees until it is repaid in full, without any limitations.
Why Do Some Lenders Require Personal Guarantees?
Lenders require personal guarantees to reduce their risk when lending to businesses. It’s hard to blame them considering that half of U.S. businesses don’t survive more than five years. By requiring owners to back the loans, lenders have a route to recovery if businesses can’t pay as agreed. This can enable lenders to extend more loans to more businesses with more competitive interest rates.
While the need for a personal guarantee may in some cases depend on whether a business has collateral and/or established credit, many lenders today require a personal guarantee for all of the business loans they extend.
Which Business Loans Require Personal Guarantees?
Most business loans you’ll find on the market today will require personal guarantees, including the following:
The U.S. Small Business Administration (SBA) offers a variety of loans for small business owners through its network of approved partner financial institutions. You can apply through the partner banks for various loan programs like the SBA 7(a) loan and the SBA promises to repay up to 85% of any loss in the case of default. However, even though the SBA is backing the loans, they still require a personal guarantee from borrowers.
Online Small Business Loans
Many online small business loan lenders have cropped up in recent years and most of them require personal guarantees. They make getting a business loan very fast and easy as you can complete the whole process online without even leaving your couch. However, part of the reason they can streamline the process is because their risk is mitigated by requiring personal guarantees. Examples include companies like Kabbage, Funding Circle, and OnDeck.
Pro tip: If you’re worried about getting approved because your credit is less than stellar, there are some lenders that specialize in funding business owners with fair to bad credit.
Brick-and-Mortar Banks and Credit Unions
Many traditional brick-and-mortar financial institutions like Chase and Wells Fargo offer SBA small business loans which will require personal guarantees as we covered above. Beyond that, most also offer their own loans and lines of credit which will require one of the owners to act as a personal guarantor.
Business Credit Cards
Most major business credit card issuers like Chase and Capital One will require a personal guarantee on their business credit cards. One of the owners will need to meet the issuer’s minimum credit requirements in order for the business to qualify.
How Lenders Assess Your Personal Credit
Business loan lenders will assess your personal credit by checking your credit report and FICO score. Similar to analyzing creditworthiness for a personal loan or credit card, they will be looking for signs that you are trustworthy and you meet your credit obligations.
Any derogatory marks from things like late payments, accounts in collections, or judgments will be red flags that could cause them to deny your business loan application.
Pro tip: Most business lenders will list a minimum personal credit score as part of their eligibility requirements. For example, On Deck requires a minimum FICO credit score of 600 but reports that most borrowers have scores between 680 and 720. You can save time by checking your credit scores and the eligibility requirements of lenders before you start applying and getting quotes.
Risks and Benefits of Personal Guarantees
Personal guarantees have pros and cons. It’s important to understand both before signing on the dotted line so you don’t face any surprises down the road.
First, here are the risks to consider:
- Personal liability: When you provide a personal guarantee, you are responsible for the business debt which can put all of your personal assets at risk, along with those of your spouse (if you’re married). It’s important to ensure you can comfortably cover the payments if you need to.
- Damage to your credit: If you and your business default on a loan, the lender can report it to the credit bureaus which will hurt your personal credit score for up to seven years.
- Legal action: If you don’t pay as agreed, the lender can take legal action against you to collect the debt. Further, you may be liable for their legal fees in addition to yours.
It’s not all bad — here are the benefits:
- Access to funding: If you have decent personal credit, you can gain access to a business loan without business credit.
- Better rates and terms: The personal guarantee can help to remove some of the risks lenders face in lending to you. As a result, you can get larger loans, longer repayment terms, and better rates.
- Easier application process: With the personal guarantee, a lender won’t need to vet your business as deeply because their risk is covered by the owner’s personal credit. That can make for a shorter application, approval, and disbursement process.
- Doesn’t count against DTI ratio: In most cases, a personal guarantee won’t cause a loan to show up on your credit report so it won’t count against your debt to income ratio. This is helpful because it won’t limit what you can borrow for personal reasons (such as a mortgage or auto loan).
Should You Avoid a Personal Guarantee?
Personal guarantees shouldn’t be immediately discounted on principle alone. They can be a good solution for the many people who need business funding but can’t get it based on their business credit or available collateral.
However, you should definitely understand the implications. Run through the worst-case scenario (defaulting and not being able to pay) to decide if the benefits outweigh the risks.
You may decide in favor of a personal guarantee but might want to borrow less to limit your level of liability. On the other hand, you may decide that you want to look for alternatives so you won’t be personally responsible for business debts in any way, shape, or form.
Alternatives: Loans Without Personal Guarantees
If you’d rather keep your personal and business finances completely separate, here are some financing solutions that won’t require a personal guarantee.
Merchant Cash Advances
Merchant cash advances (MCAs) are lump sum cash advances offered to business owners. Instead of using your personal or business credit to determine eligibility, MCA providers will look into the credit card records on one of your merchant accounts. If approved, you can receive a lump sum advance that will be repaid by a percentage of your daily credit card sales (often 10 to 20%).
The costs of MCAs are based on factor rates which often range from 1.2 to 1.5. To figure out the total cost, you multiply the loan amount by the factor rate. For example, if you were offered a $50,000 MCA with 1.2 factor rate, you would multiply $50,000 by 1.2 to get a total cost of $60,000. When converted into APRs, MCA fees range anywhere from 40% to 350%, so they can be on the expensive side. Be sure you’re aware of the costs and how they’ll impact your cash flow before going this route.
Loans from Companies that Process Payments
Companies that process business payments for their customers, like PayPal, Stripe, Square, and Shopify, have increasingly offered loans that are similar to merchant cash advances. They are often based on the account holder’s sales volume and history. If accepted, you receive a lump sum and then repay it through a fixed percentage of your sales over time.
The loans typically come with a borrowing fee which is added to the loan amount. While a personal guarantee isn’t required to qualify, you will have to use the platforms and wait until they approve you in order to get funding. Like MCAs, the fees can be on the expensive side. However, you often have a few options so you can get a lower fee if you opt for a higher daily repayment percentage.
Invoice factoring, or invoice financing, involves you selling your invoices to a factoring company at a discount. The company then collects the payment from your customers. This can help your company if you have outstanding invoices that sit for 30 to 90 days, or more.
Approval is often based on the creditworthiness of the customers that pay you, instead of your personal or business credit. Factoring companies may also require a certain amount of invoice history, a minimum amount of annual revenue, and that your customers are businesses rather than consumers.
Business Credit Cards
While most business credit cards require personal guarantees, there are a few notable exceptions including the Brex card and the SVB Innovators card. The Brex card is only available to non-individual liability companies in the U.S. with Employer Identification Numbers (EINs). However, companies of any size with any amount of revenue can apply. The SVB Innovators card is offered to companies with a business banking relationship with Silicon Valley Bank.
Last Word on Personal Guarantees
Personal guarantees on business loans don’t have to be deal-breakers — but they can be for some. It all depends on your situation. While they can help you get a business loan without business credit and are widely available today, you will want to avoid them if you don’t want to be personally responsible for your business debts. The good news is, there are alternative funding options that won’t require a personal guarantee and won’t even check your credit. However, they often come with a higher cost so you’ll have to weigh the pros and cons.