Why lenders require personal guarantees for business loans

If you’re looking for financing for your small business, you may have heard the concept of leveraging “Other People’s Money (OPM)” to fund your business. In theory it’s a great idea: let someone else fund your business, and avoid the risk that if things don’t work out, you’ll be stuck with the financial consequences. 

In reality, lenders know that starting a business is risky, and one way they manage that risk is by requiring personal guarantees. 

Here’s why lenders may require personal guarantees from small business borrowers, and what you should know about them as a business owner. 

Understanding personal guarantees in business lending

When you sign a personal guarantee for a business loan, you agree to repay the loan yourself if your business can’t pay it back. Think of it like co-signing a car loan for a friend or family member; if they stop making payments, you’re responsible for them.

With a personal guarantee, the applicant pledges personal assets and/or income to repay the debt if the business does not. 

When and why lenders require personal guarantees

Any business loan represents risk for the lender — the risk of not getting repaid in full. Before approving your application for a loan, line of credit or other financing,, the lender is going to take steps to help them feel confident that doing business with you is a good decision.

To reduce its exposure to risk, a lender needs to believe that the odds of you repaying your loan are acceptable. As a result, most lenders will want to make sure that your business is financially sound and can demonstrate creditworthiness through a history of on time payments. 

Your lender may want to ensure that you have a little “skin in the game”, so to speak, personally as well.

Banks and lenders often require small business owners to sign personal guarantees to protect themselves, especially when lending to:

• New businesses without a long track record
• Companies with limited business credit history
• Businesses with few assets or collateral

With a business loan that doesn’t require a PG, only your business assets are at risk if you can’t pay. But with a personal guarantee, your personal assets – like your home, car, or savings – could be pledged to repay the loan.

Most traditional lenders want to see that you’re personally invested in your company’s success. A personal guarantee demonstrates your willingness to put your own assets on the line. Plus, personal guarantees offer more options for the lender to collect if your business defaults. 

For example, if you’re opening a new restaurant and need $100,000 for equipment and renovations, many lenders will want a personal guarantee before approving the loan – even if your business plan is solid. This is because new restaurants are considered risky.

Types of personal guarantees

Before you apply for business financing, understand the two main types of guarantees lenders might require:

Limited personal guarantees cap the guarantor’s personal responsibility at a specific amount. For example, if you and your three business partners each sign a limited guarantee on a $300,000 loan, you might each be responsible for one-third of the outstanding loan amount.

Unlimited personal guarantees make you responsible for the full amount of business debt, plus interest rates and fees. That means you (and business partners, if you have them) will each be liable for the entire loan amount. Most small business loans and SBA loans require unlimited guarantees, especially for startups and new entrepreneurs. 

The type of loan you get may also affect whether you need to sign a personal guarantee:

Term loans from traditional banks usually require strong personal credit and a guarantee from any owner with more than 20—25% stake in the business.

Business credit cards almost always require personal guarantees, making the guarantor responsible for all business debt on the card.

SBA loans guaranteed by the Small Business Administration typically require personal guarantees from anyone owning 20% or more of the business.

Secured loans might still require personal guarantees, even if you offer business assets or real estate as collateral for the loan. 

Risks of signing a personal guarantee

A personal guarantee means your business loan becomes your personal responsibility. 

Here’s what that means for you:

Your personal assets are at risk. If your business can’t repay the loan, the lender can go after certain personal assets which may include your house, personal bank accounts, or other valuables, to cover the debt.

Your credit score could suffer. A business loan default may show up on your personal credit reports, and could affect your scores for up to seven years.

Your spouse might also be responsible. In some cases, lenders require both spouses to sign the guarantee, putting both people’s assets at risk.

How to avoid personal guarantees

First, it’s not always possible to avoid a personal guarantee, especially if your business is new or doesn’t have strong cash flow. Still, here you can take steps to reduce your chances of needing one:

Build strong business credit. Good business credit scores show lenders your company is likely to pay back new financing. Start by getting tradelines or opening a business credit card and always paying on time.

Offer business assets as collateral. If your business owns valuable equipment or property, you might be able to use these instead of a personal guarantee.

Save for a larger down payment. A bigger down payment may mean less risk for the lender, which might help you avoid a personal guarantee. This doesn’t apply to all types of business loans; business lines of credit don’t require down payments, for example, but it may help with commercial real estate loans or similar types of financing. 

Form a business entity. If you operate your business as a sole proprietorship, there is no legal separation between you and your business. You will be personally responsible for any debt you take out, as it’s essentially a personal loan. 

Alternatives to personal guarantees for business loans

Several financing options don’t typically require personal guarantees:

• Merchant cash advances offer an advance against future sales. The financing company looks at your business credit card sales and/or business revenue instead of requiring a personal guarantee.
• Invoice factoring turns your unpaid customer invoices into immediate cash. The factoring company collects payment directly from your customers.
• Payment processor loans often base lending decisions on your sales history through their platforms.
• Crowdfunding typically does not require a personal guarantee. 

What to do before signing a personal guarantee

Before you agree to a personal guarantee, take these steps to reduce your risk. 

Monitor your cash flow

Before taking on personal responsibility for business debt, review your business’s cash flow carefully. Make sure repayment (whether it’s daily, weekly, or monthly) won’t strain your operating budget.

Check eligibility requirements

Business lenders may each have their own loan requirements. Key factors providers may consider in deciding whether to require a PG may include: 

• Time in business
• Annual revenue and/or cash flow
• Business credit scores
• Personal credit history
• Available collateral
• Business structure

Understand personal liability

Review how the personal guarantee affects your personal finances, including:

• Your savings accounts
• Personal bank accounts
• Real estate holdings 
• Future borrowing ability

Talk with business partners

Partnerships need to discuss how personal guarantees will affect each owner. Consider questions like:

• Will all partners sign as guarantors?
• How will you handle repayment if the business defaults?
• Should you create a written agreement about personal responsibility?

Just remember that any agreement with the lender supersedes and personal agreements made between owners. In other words, the loan agreement is doing to dictate what the lender can and cannot do to collect. 

That leads to the next piece of advice:

Read the loan agreement

This should spell out what assets are pledged and under what conditions the lender may try to collect from them.

Review any limits on the personal guarantee. Some guarantees cap your personal liability at a certain amount or percentage of the loan.

Negotiate 

You might be able to:

• Limit the guarantee to a specific dollar amount
• Set an expiration date
• Remove your spouse from the agreement

You might even be able to convince a manager to waive the requirement if you ask, especially if your business credit history and other qualifications are strong.

Finally, it’s always a good idea to consult your own small business attorney. They can explain the legal implications and help you understand exactly what you’re agreeing to.

Nav’s verdict: Personal guarantees

Personal guarantees are a common part of business financing, especially for startups and smaller businesses with more limited revenue and/or a weak business credit history. 

While PGs increase your personal liability, they also open doors to financing options that might otherwise be unavailable. In other words, they aren’t always a bad idea. 

Understanding the types of personal guarantees, reviewing loan requirements carefully, and protecting your personal assets can help you make informed decisions about business debt.

Nav can help your business find the right financing. Learn how to build, manage and monitor your business credit, and find financing options based on your business data. 

Frequently asked questions

Can you get business loans without personal guarantee?

Yes, but your options are more limited. Some loans that rarely require personal guarantees include:

• Merchant cash advances based on your credit card sales
• Invoice factoring using your unpaid customer invoices
• Payment processor financing 
• Some corporate credit cards, usually for for established companies
• Crowdfunding

These options often cost more than traditional loans, but they keep your personal assets separate from your business.

Otherwise, the decision as to whether a PG will be required will depend on the lender, your business qualifications and the type of loan or financing. 

Does every loan require a personal guarantee?

No, but most traditional business loans do. In that case, your chances of needing a personal guarantee are higher if your business: 

• Is less than two years old
• Has a limited business credit history
• Brings in less than $10 million a year in revenue
• Your company has few assets
• Seeks SBA loan or business credit card

Does LLC require a personal guarantee?

Operating as an LLC doesn’t automatically mean you don’t need to agree to a personal guarantee. Most lenders will still require one, especially for LLCs:

• Without strong business credit
• Seeking traditional bank loans
• Applying for business credit cards
• Without significant business assets

The legal structure of your business matters less here than its financial strength and credit history. (Though an LLC can get a loan without a PG, while a sole proprietorship is inherently offering a PG.) 

Which businesses typically need a personal guarantee in order to receive a loan?

Personal guarantees are most often required for:

• Startups and businesses less than two years old
• Companies with annual revenue under $10 million
• Businesses with limited credit history
• Service-based companies with few physical assets
• Small retailers or restaurants
• Online businesses without significant inventory

Established businesses with strong revenue, substantial assets, and good credit histories are more likely to qualify for loans without personal guarantees.