Small business owners frequently need to offer a personal guarantee to get commercial financing. Sometimes, these guarantees can cause anxiety for owners — it’s a little uncomfortable to put your personal assets on the line to secure the financing you need. So, why do lenders ask business owners for these personal guarantees?
In this article, we’ll talk about personal guarantees, including why lenders want them and how they work.
Small businesses may have a limited credit history, which means they pose a fair amount of risk to a lender. Credit history is often the first thing a lender looks at when working to approve your loan. A lack of credit history can make it more difficult for a lender to understand how you’ve treated lending institutions in the past.
When a business owner provides a personal guarantee to secure a loan, they are promising to pay back the loan personally if their business defaults. Because of their flexibility, personal guarantees have become more common in recent years, especially since the 2008 financial crisis and recession.
Personal guarantees are often used as an alternative to loan covenants. A loan covenant is a clause in a loan where the borrower agrees to certain conditions and restrictions. Loan covenants can serve a purpose, but for most borrowers, a personal guarantee is simpler and more flexible. Some loan covenants can be overly restrictive and complicated, which may cause borrowers to violate the covenant on accident, possibly without even knowing it.
In general, there’s a strong relationship between personal credit and small business credit; if a small business owner has good personal credit, chances are their small business is creditworthy.
It can be intimidating for a business owner to put their personal assets on the line to get financing — but that’s also part of the reason why these guarantees are effective. The personal guarantee shows the financing partner that the business owner has “skin in the game” and is committed to repaying the credit.
A personal guarantee is more of a safety net for a lender than anything else. If your business is able to meet its debt obligations, your personal cash advance payday loan Missouri assets won’t be at risk. Often, the most important function of a personal guarantee is to show the lender that you’re strongly motivated and serious about establishing a successful business.
Personal guarantees also offer some distinct advantages for borrowers. A guarantee can give you more financing options and help you secure a loan when you don’t have collateral that you want tied to a loan. And since a personal guarantee makes the transaction less risky for the lender, signing the guarantee may allow your lender to make your loan more affordable or otherwise offer more favorable financing terms.
However, it is important to remember that you take on responsibility when you sign a personal guarantee. Before you sign a guarantee, you should feel very confident about your ability to repay the loan.
Even if a lender asks for a personal guarantee, you may have some room for negotiation and flexibility, especially if you work with an independent financing partner like Team Financial Group.
For example, you may want to ask if the lender will either put a time limit on the guarantee or agree to review the guarantee after a certain amount of time. Often, the lender is asking for the guarantee because your business hasn’t been around long enough to establish a track record of financial responsibility. After a couple of years, they may have a better understanding of your business’ current situation and history of profits, and they may be willing to remove the guarantee at that point.
At Team Financial Group, we offer flexible payment terms tailored to meet your business needs. Our application process is easy and won’t affect your credit score, so apply today to get started.
If you have any questions about the financing application process or which financing option is right for your business, fill out our online contact form or call us at 616-735-2393. We’d love to chat with you about your options.