It is wise that retailers understand all the risks that come with giving personal guarantees on a small loan or any line of credit. Many financial providers expect that your business signs personally – which may out turn out well if the micro-business fails to repay the debt as it may impact negatively on their personal credit and finances as well.
But issuing a guarantee is also the standard for most commercial loans, and business owners shouldn’t shy away from it if it can help save their companies.
Why do lenders ask for personal guarantees?
Financial security— the certainty they’ll have their money back— is the main reason lenders insist on guarantees before they offer businesses funding. Lenders want to be sure a responsible person has invested in the firm and is running the business. And whether you want a line of credit, loan, business credit card or equipment financing, a personal guarantee is what they use to secure the funding.
What’s a personal guarantee offered for a business loan?
Guarantees, like collateral, are issued by business owners to lenders who are reluctant to give financial help unless they are sure they’ll get paid back. With personal guarantees, a lender secures the loan by relying on a percentage of the personal stakes of a business owner.
Most lenders secure loans by taking a personal guarantee from a company owner or executive with not less than 20% stake in the business. That way, they are sure to recover their remaining finances if the small business defaults the debt.
How does a personal guarantee affect your business and personal credit?
The impact of a micro-business loan on both personal and business credit will depend on how the merchant pays it back and the bulk of debt already on your back.
If the guarantee is attached to personal credit, any default will lower your credit limit and may make it extremely difficult for you to take a mortgage or personal loan.
Defaulting payments leads to a collection and eventually judgments which adversely affects your credit score when your lender reports to your bureau.
The bottom line is; a personal guarantee puts your personal funds, credit and business credit at risk.
And for merchants who have not separated personal finances from company funds and still have no business credit profile, the result could be a bare business credit report, extreme difficulty in borrowing and perhaps the need for a credit repair merchant account.
The Two Types of Personal Guarantee
- Unlimited personal guarantee
It authorizes your lender to take 100% of the loan amount plus any legal fees payable by defaulters. Essentially, the financial provider could collect personal assets like your savings account, car, home, and retirement funds. However, most states protect their constituents’ main homes and retirement funds from creditors.
- Limited personal guarantee
Here, the lender and borrower agree on a limit so that you remain only accountable for the predetermined liability in the event you default the loan. Limited guarantees are common where several executives (with 20 % stakes or more or more) in the company choose to sign up personally for a loan.
Before signing a limited guarantee contract, make sure to find out what happens if you trade your portion of the company and keep in mind that your business model won’t supersede your legal responsibility on that loan.
Inquire more about the type of contract you are agreeing to before putting your pen on the dotted line.
Author Bio: As an account executive, Michael Hollis has funded millions by using alternative funding solutions. His experience and extensive knowledge of the industry has made him a credit repair merchant account expert at First American Merchant.