When starting or running a business, you may be asked to sign a personal guarantee for a business loan or line of credit. While this can provide needed capital, it also puts your assets at risk if the business defaults. Understanding how personal guarantees work is key to protecting yourself.
What Exactly is a Personal Guarantee?
A personal guarantee is a legally binding contract where an individual agrees to repay a business debt if the business itself cannot. For lenders, guarantees provide an extra layer of security that the loan will be repaid. As the guarantor, you are “co-signing” for the business by putting your net worth and assets on the line.
How Personal Guarantees Attach to Assets
Signing a guarantee gives creditors access to your personal assets if the business defaults. This includes bank accounts, investment accounts, real estate, and other valuables. Creditors can seize assets or garnish wages to settle unpaid debts.
Limiting the Scope of Guarantees
Before signing, request limitations to minimize risk. For example, ask that the guarantee decrease over time as the business grows. You may also seek to cap the guarantee at a percentage of business ownership. While lenders may push back, it’s worth negotiating terms.
Asset Protection Planning
Once signed, transfers of assets to protect them from creditors may be deemed fraudulent. However, some options like trusts and LLCs set up before signing the guarantee have a better chance of holding up.
Some lenders may release guarantees if the business meets certain milestones or pays down debt. Be sure to understand available options to be released from liability in the future.
Personal Loans with a Cosigner
For personal loans with a cosigner, having one with good credit helps you qualify if your credit is limited. However, cosigners share legal responsibility for repaying the debt. Both your credit scores suffer if payments are late.
Evaluating Overall Risks and Rewards
Before committing personal assets, carefully weigh the risks and rewards. Be realistic about the likelihood of business success and loan repayment. Understand exactly what you are putting at stake before signing anything.
While personal guarantees are risky, they may provide the funding needed to start or expand a business when other options aren’t available. Taking steps to limit liability and protect assets can help minimize exposure. Above all, avoid signing a guarantee unless you fully grasp the legal implications.
Consulting Professionals Before Signing
Given the gravity of personal guarantees, it’s wise to consult professionals before signing anything. An attorney can review the guarantee agreement and help negotiate favorable terms. A financial advisor can analyze the overall risks to your assets and net worth. An accountant can assess the business’ finances and capacity to repay debt.
While their services cost money upfront, the insights gained can prevent much larger losses later. Professionals may identify risks or alternatives not readily apparent to business owners caught up in expansion plans. They can also advise on asset protection strategies, insurance options, and contingency plans.
At minimum, discuss guarantees in depth with your legal, financial and tax advisers beforehand. Ask lots of questions and understand all possible outcomes. Educate yourself on the implications so you don’t unwittingly put your family’s livelihood and retirement at risk. While guarantees provide access to capital, make sure you enter them with your eyes fully open.
Personal guarantees legally attach personal assets to business debts. This risk can be reduced through negotiating terms, asset protection planning, and understanding options to end liability over time. When used with eyes wide open, guarantees can provide business capital despite credit challenges. However, they should not be entered into lightly.