What is a personal guarantee?
A personal guarantee, also known as a commercial guarantee, is a legal contract between a lender and business owners, their families or other individuals to guarantee a specific obligation of a business. The people who sign the guarantee (known as “guarantors”) agree that, in addition to other forms of recourse, a lender has the right to pursue their personal assets if the loan should go in default.
Why do lenders require a personal guarantee?Lenders require personal guarantees primarily for three reasons:
- To motivate management or the business owners to continue to support the on-going operations of the business.
- In the event the business is unable to repay the loan, the personal guarantee provides significant leverage for the lender to encourage management to act in a manner benefitting the lender’s interests.
- The personal guarantee adds secondary collateral (an individual’s net worth) to the primary collateral (business assets).
Is it common practice for lenders to require a personal guarantee?
It is common practice for lenders to require a personal guarantee on loans to small and medium-sized businesses.
A personal guarantee is not a sign that a business is unhealthy. Even the owner of a business with a solid track record and strong operating performance may be required to guarantee a loan to that business.
What are the risks of signing a personal guarantee?
The risks are significant for most guarantors. By signing, the guarantor provides the lender with direct access to personal assets as collateral for a business loan. If the business defaults on the loan, the guarantor risks losing his or her home, savings and other items of value that the lender may pursue to satisfy the loan obligation penalties and all other costs.