A Small Business Owner’s Guide To Personal Guarantees

January 10, 2020
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Donny Raw
Posted in Finance
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From advice by author and CPA, Shaila Chamberlain, today’s post is devoted to de-mystifying the dreaded personal guarantee. Read on and you’ll learn exactly what a personal guarantee is, what it isn’t, when and how you can avoid a PG, and when a guarantee is absolutely necessary.

The Personal Guarantee Defined

Essentially, a personal guarantee is simply a written promise from a business owner to a lender agreeing to take over repayment responsibility if the business, for whatever reason, fails to pay. Creditors frequently require personal guarantees for a range of different business lending products, including leases, commercial loans, and lines of credit. Personal guarantees are more often required of owners of small businesses than large ones.

Why Do Lenders Like Personal Guarantees?

Personal guarantees are appealing to lenders because they represent added assurance that a business’s financial obligations will be met. From the lender’s point of view, a personal guarantee is simply a demonstration that the owner is willing to stand behind his or her company. An owner who refuses to supply a personal guarantee inevitably appears more risky to lenders.

A personal guarantee gives the lender a recourse to pursue if the business happens to default on its payment obligations. The creditor is, essentially, getting a “backup” method of ensuring that the company pays its debts. You may have invested significant effort in limiting your personal financial liability in your business by organizing it as a limited liability company or a corporation. You end up being personally responsible for your company’s debts anyway if you supply a personal guarantee to secure financing for your business.

For small business owners, lenders will usually request a personal guarantee for a range of different products and services. Examples include:

* Traditional loans and lines of credit from a bank

* Invoice factoring

* Online loans

* Revolving lines of credit (personal guarantees are not always required for these)

* SBA Loans

The Limits Of Personal Guarantees

One of the largest misconceptions small business owners have regarding personal guarantees is the notion that they always affect the owner’s personal credit history. Your creditor does not necessarily need to report your new financial obligation to the consumer credit bureaus. A lot of business owners believe this to be the case with all personal guarantees, but it is not. Financial obligation data-sharing rules vary from creditor to creditor.

Take our own unsecured business credit lines program (UBF), for instance. We do require a personal guarantee to use this program, but payment activity and debt information related to those lines is not reported to the consumer credit agencies. Data on these business credit lines goes only to the agencies that track business credit.

When And How To Avoid A PG

It is notably easy to get a net account without being forced to supply a personal guarantee. Vendors consider their risk in these situations to be minimal because of the short credit terms (typically 30 to 60 days) involved. Many vendors require down payments on each order, rather than a personal guarantee, to reduce their risk.

Equipment and vehicle leases are other business credit products that can often be secured without a personal guarantee. In these cases, the material goods purchased with the lender’s money serves as collateral that protects the lessor from loss risk. This is an area where policies vary based on the lender and borrower involved. Many lenders will waive the requirement for a PG only if your company can show strong business credit reports and or healthy financial statements.

GM’s Right Lease program is a useful example in this case. These products are closed-end commercial leases that you can secure using either a personal or corporate guarantee.

Personal guarantees are often avoidable if your company is well-established. Strong revenues, a long history of operations (over several years) and a large contingent of employees all help. Lenders simply consider medium and large-sized businesses far less likely to default on their obligations.

Sam’s Club Business MasterCard, for instance, waives the requirement for a personal guarantee if your company’s annual sales exceed $5 million or your company has been in business for at least two years and has at least 10 employees. A strong business credit report is also a necessity here; Synchrony Bank will check your company’s credit in the course of handling Sam’s Club underwriting.

An exceptionally strong business credit report may allow your company to obtain credit from certain card issuers without the need for a personal guarantee.

How Strong Does A Business Credit Report Need To Be To Avoid A PG?

At a bare minimum, a business should be reporting to the three main business credit bureaus (Experian Business, Equifax Small Business, and Dun & Bradstreet) on at least 10 trade lines. At least one of these should have a credit limit of $10k or more. 12 months of sterling payment history and a diverse credit portfolio are also important.

How Can I Get Business Credit Without A Personal Guarantee?

The following five-step process can make it easier for your company to secure credit without forcing you to provide a personal guarantee:

1: Establish 10 vendor accounts, all reporting to the business credit agencies. (Use our Business Credit Building System to make this easy.) Use your credit lines to make business-essential purchases and pay your invoices in a timely fashion. This builds up your company’s positive payment history with the credit bureaus. For personal-guarantee-free financing in this phase, remember that you can get net 30 credit terms from many vendors without a PG.

2: If your personal credit is good, consider enrolling in our UBF program. This provides your company with three or four revolving lines of credit, without reporting any activity on your personal credit history. These revolving lines of credit are good for building up your credit diversity; all are provided by banks that report to the business credit bureaus.

The UBF program gives a business access to cash on demand and makes it possible to look forward to credit limit increases on a 6 to 12-month basis. You can also secure 0% APR on purchases for significant periods: 9, 12, or 24 months.

If your personal credit is not good, a workable alternative to this step is to open one or two secured business credit cards.

3: Establish one or two fleet cards that report to the business credit agencies. A fleet card is a generally useful account to have as it can take care of fuel purchases and routine vehicle maintenance throughout your business. Fleet cards differ from general business credit cards as they are expressly designed to meet vehicle expenses. A fleet card is practically a necessity if your business operations involve significant vehicle usage. These cards build up positive payment activity on your business credit history.

4: (Optional) In the company’s name, lease a vehicle or essential equipment.

5: After following the above steps, your company will be ready to apply for the business credit card accounts in our business credit building system. With the right preparation, this can be done without a personal guarantee.

Personal guarantees are quite old. They are being required by more and more lenders, though, because banks are growing increasingly cautious in dealing with small businesses. While some forms of credit simply cannot be secured without offering a personal guarantee, there are alternatives (like those described above) for small business owners to consider.

It’s important to keep in mind that you can approach a lender to renegotiate guarantee terms even after you’ve signed a personal guarantee. This is a worthwhile avenue to explore when your company experiences a positive change in its financial resources. If your revenues strengthen, for instance, or you acquire additional collateral, it may be in your best interest to renegotiate.