Written by Team 365 finance
A personal guarantee is a guarantee made by an executive or partner in a business to take on responsibility for credit issued to the business’s in the event the business is unable to repay its debt.
When an individual provides a personal guarantee, they become personally liable for the debt if the business is unable to repay it.
Personal guarantees are typically used to provide extra security to creditors that lend money to a business. For example, an owner of a business may provide a personal guarantee in order to secure a line of credit that’s necessary for the business’s continued operations and growth.
Below, we’ve explained what personal guarantees are, how they work and the ways that they’re commonly used by businesses. We’ve also looked at some of the advantages and risks offered by personal guarantees, both from the perspective of creditors and guarantors.
What is a Personal Guarantee?
A personal guarantee is a promise made by an owner of a business or executive to repay debts in the event that the business is unable to repay them.
Personal guarantees are common in small businesses, where the owners of a business have a personal stake in its success. Offering a personal guarantee can make it easier for a relatively new, unproven business to access the capital it needs to develop and grow.
If a business defaults on a debt that’s backed by a personal guarantee, the guarantor could be held responsible for repaying the debt.
This means that providing a personal guarantee can be a risky decision for a business owner or executive, especially if the business is new and has yet to develop a consistent source of cash flow and profits.
How Are Personal Guarantees Used?
Personal guarantees are most commonly used to secure a loan or other line of credit for a new business. However, they can also be used to access other forms of financing. A business owner or executive might provide a personal guarantee in order to:
- Enter into a commercial lease. Some commercial property leases require a personal guarantee. This guarantees that the lease will be paid up to its completion in the event that the business leasing the commercial space closes.
- Enter into an equipment lease. Like with commercial property leases, certain leases for equipment require a personal guarantee from a business owner or executive.
- Borrow money. The most common use for a personal guarantee is to borrow money, whether in the form of a business loan or line of credit. Providing a personal guarantee offers extra security for the lender, especially when loaning money to a new business.
Personal guarantees are typically used by small business, startups and other businesses that don’t yet have consistent cash flow or significant assets. Larger businesses, especially those with an established credit profile, can often borrow money without a personal guarantee.
Advantages of a Personal Guarantee
For a small business, the biggest advantage of a personal guarantee is that it provides access to credit that would otherwise be unavailable. By providing a personal guarantee, the owners of a small business can access a line of credit, business loan or other source of financing.
Since access to capital is essential for business growth and development, providing a personal guarantee and securing credit is often an important step in getting a small, growing business off the ground.
For a lender, the main advantage of a personal guarantee is that it provides extra security when lending money to a business that doesn’t have significant cash flow or assets that can be seized if it defaults on the loan.
Disadvantages of a Personal Guarantee
As a guarantor, providing a personal guarantee can be quite risky. If your business doesn’t grow as expected and it’s unable to repay the loan through its regular cash flow, there’s a serious risk that you could be held personally liable for repaying the loan using your own assets.
This makes it important to carefully plan ahead and make sure your business has a proven, real business model before you seek out any forms of financing backed by a personal guarantee.
Personal guarantees can also cause complications if you sell your business to another person or commercial entity. If you opt to sell your business and its debts are secured using a personal guarantee, it’s important to make sure you’re released from the guarantee prior to the sale.
If you decide to start a small business, there’s a good chance that you’ll need to offer a personal guarantee in order to secure a loan or other line of credit. Offering a personal guarantee can be an important step in helping your business access capital and start growing.
As with all decisions that affect your personal assets, it’s important to think carefully before you enter into a personal guarantee. Before providing a guarantee, carefully consider the viability of your business in both the short and long term.