Personal Guarantee Clause – Giving Your Business a Leg Up
A big piece of my job is finding funding for my clients. The funding I find for them can come in a variety of forms, but typically they include some type of loan. Regardless of the loan I recommend, the loans all include a personal guarantee clause (PGC).
In another post, I mentioned that corporations were separate entities from the shareholders, founder, and employees. As such, the corporation is responsible for its own debt. The issues banks and other lenders have with that is the lack of credit a corporation might have. Top that with the spotty cashflow of new businesses, and lenders can find themselves in very risky positions. Keep in mind, this doesn’t just pertain to corporations. An LLC and partnership (depending on how it’s structured) also may free the owners of any liabilities associated with the business. And though the owner is completely responsible for business debt, they may even see personal guarantee clauses.
The clause is a way to hold the owners, shareholders, and/or founders accountable for paying back a loan in the case the business folds. The PGC is like cosigning for a loan, but the other borrower is your company. Instead of looking at the business’s credit, which may be nonexistent, it looks at the credit worthiness of the owners. This allows a bank to participate in a riskier loan while still being able to collect if the business is unsuccessful.
Some individuals may feel leery about agreeing to put their personal guarantee on a business loan. Resisting speaks volumes for your faith in the business. Banks will see your resistance as evidence that you believe the business will fail. And if you’re not willing to back your business, the bank is less likely to approve your loan. That doesn’t mean you can’t negotiate yourself out of a PGC. However, it’s important that you choose your battles. For example, if you business already has established credit (good credit, that is) and a sustainable business model that’s bringing in healthy profits, a PGC may not be necessary. In fact, the PGC may just be a standard clause in the lender’s form.
Though personal guarantees helps the bank, it also benefits your business. If you’ve ever needed an individual to cosign for you, you realize that even though your credit was spotty at the beginning of the financial contract, by the end (if you paid as according to the agreement), your credit improved. Likewise, this gives your business and opportunity to build its credit.
What misgiving do you have about giving your personal guarantee on your business loan?
This is a very informative post on Personal Guarantees. I know banks well enough to know they’ll do anything possible to reduce their risks. I also know a PGC will give them about everything you have so you need to be very confident in your business to sign one. At the same time I understand how the bank would wonder if you don’t have enough confidence in your own business why should they. Very informative and thought provoking !
Thanks for stopping by, Mike. I’ve also found gap and non-conventional lenders require a personal guarantee also. They’re usually more at risk than the banks. Gap and non-conventional lenders often take a 2nd or 3rd position. As such, the chances of them getting paid out in case of a business going under is slim to none. A personal guarantee allows them to at least get a judgment on the entrepreneur in the case of a default.
On a side note, despite the risk to non-conventional lenders, sometimes borrows can get a better deal with them than the bank. I encourage entrepreneurs to investigate what’s offered at the local and state level for funding opportunities.
Thank you for your great advice on personal guarantees. I’m not a big fan of borrowing money and paying interest but from a business perspective it is valuable to build credit and leverage your credit to produce more profits. I really appreciate your wise words here this information has really benefited me you should be very proud of your content on this site it is truly awesome and very valuable. stay blessed
Thank you for stopping by, Brian. I can see why you’re not a huge fan of borrowing money. Debt is a huge problem for Americans, and I imagine for other countries also. Often times I get clients who have the money to fully fund their business. They find getting a loan allows them to keep money tucked away for working capital, which is often times difficult to finance.
Hi Renee- I have been a small business owner for many years and would have to agree. When someone does not want to sign a personal guarantee it would not give me much confidence in them. What do they know that they are not telling? If someone believes in their business it should not be an issue.
I really like your homepage as well, looks like you have put a lot of time into this. Good luck.
Thank you for stopping by, Scott. Of all my dealings, I’ve only encountered one entrepreneur who baulked at a personal guarantee. I think many are just so thankful to have someone believe in their business enough to loan them money that signing the guarantee seems a no brainer.
For this entrepreneur it was because she was creating a non-profit organization. She would be on the line for the guarantee, but in this case she would not own any interest in the company. It would mean all risk with no return (other than providing a service to the community).