If you’re trying to scale your company, finding the right type of funding for your business will be key to your success. You’ll need a steady supply of working capital to help you mitigate the cash-flow challenges that come with rapid growth. As you evaluate the types of loans and lenders available to you, you’ll learn that most lenders—banks included—will ask you to sign a personal guarantee. If you’re a first-time entrepreneur and unfamiliar with personal guarantees, here’s what you should know:
What is a personal guarantee?
A personal guarantee is a legal promise that the business owner(s) will personally repay business debt using their own assets should the business be unable or unwilling to do so. If your business ever went into collections, your lender could use the personal guarantee to recoup lost funds. Depending on your financing partner, a personal guarantee is usually implemented as a last resort when all other avenues have been exhausted.
Why do I have to sign a personal guarantee?
If you’re growing a young company, it’s likely that the business entity has yet to establish a strong credit history. Also, your personal and business finances are probably closely connected. Because of this, lenders look to the business owners for assurance that they plan to repay the debt by any means necessary should the business venture fail. When you sign on with a new financial partner, a personal guarantee tells them that you are a responsible business owner and that you intend to make every effort to ensure their capital is returned.
What happens if my business goes under?
If your business defaults and you’ve signed a personal guarantee, a few things will happen. A good financial partner will first try to recoup debt by liquidating any of your business’s collateral. Next, they’ll look at any other business assets that are subject to a lien. If you’ve defaulted on a loan because your customers haven’t paid their invoices, your lender may also reach out to your customers in an effort to pay off the debt. When all other options are exhausted, a personal guarantee sets in to cover the remaining amount due.
Can I split responsibility with my business partner?
Anybody who owns a majority share in the business can and should be involved when signing a personal guarantee with your financial partner. If you own a small business, that typically means anybody in the company who has 20% ownership or more. If you’re larger and have more equity dilution, that number might be lower. While an outside investor or silent partner would generally not be asked to sign except in special circumstances, any actively involved stakeholders should. Having all major business owners/operators sign a personal guarantee will ensure that no single person is completely liable.
Does my spouse have to sign?
Some lenders may require your spouse to also sign the personal guarantee, especially in community property states. P2Binvestor, for example, does not ask that a spouse co-sign your personal guarantee, but this is not true for all financial partners. Be sure to clarify with your lender beforehand.
As your business grows and establishes a credit history of its own, you can secure funding for your business without blurring the lines between business and personal assets. Until then, you should understand the full scope of their obligations under the personal guarantee as well as your financial partner’s rules of engagement for applying them. Most lenders would use a personal guarantee as a last resort in collection proceedings when all other avenues have been exhausted. Be sure to talk to your financial partner about how and when they would bring a personal guarantee into the collections process should one ever arise.