Do business loans require a personal guarantee?

If you’re applying for a business loan, you may come across the term personal guarantee. Many lenders ask for one, especially if your business is small, new, or lacks strong financials. But what does it actually mean, and should you agree to it? Here’s what you need to know.

What is a personal guarantee?

A personal guarantee (PG) is a legal promise that makes you, as the business owner or director, personally responsible for repaying the loan if your business can’t.

For example, if your business fails to repay the loan, the lender can come after your personal assets, this could include your savings, car, or even your home (depending on the guarantee terms).

Why do lenders ask for personal guarantees?

Lenders take a risk every time they approve a business loan, and that risk is higher if your business has limited assets, low turnover, or a short trading history. A personal guarantee provides the lender with extra security, showing that you’re confident in your business and willing to back the loan personally.

Do all business loans require a personal guarantee?

Not always. Whether a personal guarantee is required depends on several factors, including:

• Loan Type - Unsecured loans like merchant cash advances or short-term funding often require guarantees.
• Business Strength - Strong financials or valuable assets may reduce the need for one.
• Loan Size - Larger loans typically need more security, making guarantees more likely.
• Lender’s Policy - Some lenders always ask for PGs, while others are more flexible.

The risks of giving a personal guarantee

Before agreeing to a PG, it’s crucial to understand the potential risks involved, as they can have serious financial and personal consequences.

1. Personal Asset Loss

By providing a personal guarantee, you put your personal assets, like your savings, home, or car, at risk. If your business can’t repay the loan, the lender can go after these assets to recover their money.

2. Credit Score Impact

Defaulting on a business loan with a PG could damage your personal credit score, making it harder to get future loans or credit, and possibly leading to higher interest rates.

3. Ongoing Liability

You may remain personally responsible for the debt even after leaving the business or if the business closes, depending on the terms of the guarantee. Some guarantees continue until the loan is fully repaid, regardless of your involvement or the business’s status.

4. Added Pressure

Knowing your personal finances are tied to the loan can increase stress and affect your decision-making, especially during tough times for the business.

The benefits of giving a personal guarantee

While giving a personal guarantee does carry risks, it can also offer several advantages, especially if you’re struggling to secure funding through other means. Here are some of the main benefits to consider:

1. Easier Loan Approval

Offering a personal guarantee reduces the lender’s risk, making approval easier, especially for newer businesses with limited credit history or few assets.

2. Access to More Funding

With the added security of a personal guarantee, lenders may be willing to offer you a higher loan amount. This can be crucial if your business needs a larger sum to cover significant expenses, such as expansion, equipment purchases, or cash flow gaps.

3. Better Loan Terms

Signing a PG may help you negotiate better loan terms, such as lower interest rates or longer repayment periods. Since the lender has reassurance that you’re personally backing the loan, they may offer more favourable conditions.

Should I give a personal guarantee?

Giving a personal guarantee on a business loan is a big decision. Before agreeing, ask yourself:

• Can my business realistically afford this loan? - Make sure your business can repay the loan without risking your personal finances.
• Am I comfortable risking my personal assets? - Remember, your home, savings, or other belongings could be at risk if things go wrong.
• Do I fully understand the terms? - Know exactly what you’re committing to.
• Have I explored other options? - Look for loans that don’t require a personal guarantee or are secured against business assets.

Is there any way to avoid a personal guarantee?

Avoiding them can be difficult, but there are several strategies you can try, including:

Offer Business Assets as Security

You could offer business assets, such as property, equipment, or inventory as collateral instead of putting your personal finances at risk. If the business defaults, the lender can claim these assets but not your personal ones.

Apply for a Smaller Loan Amount

Applying for a smaller loan amount may reduce the likelihood of needing a personal guarantee. Lenders often view smaller loans as lower risk and might waive PGs. However, requirements vary between lenders, so it’s important to check each lender’s specific policies before applying.

Improve Your Business Credit

Building a strong business credit score, maintaining healthy cash flow, and establishing a solid financial track record can increase your chances of securing loans without the need for a personal guarantee. Lenders are more likely to offer flexible terms to businesses that demonstrate financial stability and reliability.

Consider Alternative Funding

Some options, like invoice financing, use unpaid invoices as security and often don’t require personal guarantees. Exploring all your options could help you find a way to finance your business without putting your personal assets at stake.

Before you decide

Personal guarantees aren’t always required for business loans; however, if you’re asked to sign one, it can help unlock essential funding for your business. That said, it’s a serious commitment that shouldn’t be taken lightly.

Before signing, make sure you fully understand the risks involved, carefully weigh whether the potential benefits outweigh those risks, and read the terms thoroughly. If you’re unsure, always seek independent financial or legal advice before proceeding.