What’s the biggest problem for a start-up? When you have a great idea, a solid business plan and there’s plenty of room on the market for what you’re selling, getting funding for your launch is often the only real problem.
A personal guarantee to back a bank loan is one of the options that can help entrepreneurs get their business off the ground, but you need to understand the risks involved.
What’s a personal guarantee?
Basically, a personal guarantee means that you put your own assets up and promise to personally repay the business loan if the business falls apart and can’t meet its obligation to the lender. This cuts through any “corporate veil” separating your personal assets and liabilities from that of your business that might have been created by your business structure.
Lenders typically require personal guarantees when a company is new and unproven and doesn’t have any (or enough) assets to use as collateral to secure the loan by itself. Startups have a high failure rate compared to established companies, and lenders have to mitigate their risks somehow.
Personal guarantees are not all alike. They can be limited, which restricts the lender’s ability to recover the full amount and provides some protection for the guarantor. Others are unlimited. When multiple parties (such as business partners) agree to the guarantee, then you may have an agreement that makes each of you individually responsible for the full debt if the other parties default – not just your proportionate share.
A personal guarantee is common, but the risks to your private asset, the potential impact on your credit if you default and the financial stress associated with repayment can be extreme. It’s important to carefully review the legal terms of any agreement you intend to sign – because renegotiating such an agreement after the fact can be impossible.