Definition
A personal guarantee is a legal commitment made by an individual (the guarantor) to repay credit issued to a business for which they serve as an executive or partner. It essentially ensures that a loan or other form of financial obligation will be paid if the company defaults on its payments. This personal liability means the guarantor’s personal assets could be seized in case of non-payment.
Key Takeaways
- A Personal Guarantee is a legal agreement where an individual takes personal responsibility to pay off a loan or debt if the business is unable to do so. It essentially means that if the business fails to fulfill its financial obligations, the guarantor would be liable to cover the remaining debt.
- The personal guarantor does not necessarily need to be directly connected to the business, but it’s often a company director or close relative who has a good credit history and sufficient personal assets to cover the obligation.
- This guarantee exposes personal assets to the risk of seizure in case of business failure. One should, therefore, be cautious and well aware of their obligations when signing such an agreement. It is recommended to seek legal counsel to fully understand its potential implications.
Importance
A personal guarantee is important in finance as it provides an additional level of assurance to lenders. When an individual provides a personal guarantee in the context of a business loan or credit, they are legally making a commitment to repay the debt if their business defaults.
This reduces the risk for the lender since personal assets can be used as a recourse in case of a default. It’s a pivotal tool especially for small business loans or startup loans where the business itself may not have substantial assets.
However, from the individual perspective, it does imply a higher degree of risk, as one’s personal assets are tied up with the business’ financial obligations. Therefore, understanding the implications of a personal guarantee is essential before undertaking any financial commitments under it.
Explanation
A personal guarantee serves the essential purpose of providing assurance to lenders that the debt they are giving out will be repaid. It is often used in situations where the borrower might be a risky prospect for the lender due to their lack of credit history or a low credit score.
With a personal guarantee, the borrower makes a commitment that in case of their inability to repay the loan, the lender has the right to go after their personal assets in order to recover the debt. The use of personal guarantee provides a measure of security to lenders, and as a result, they might be more willing to approve loans or extend credit to individuals or businesses that otherwise might have been a higher risk for them.
On the other hand, the guarantor is essentially putting their personal assets on the line. In the case of a business, if the business fails and is unable to repay its debts, the guarantor’s personal assets can be used to fulfill the obligations.
Therefore, while a personal guarantee can be a powerful tool to secure finances, it also brings with it a high level of financial risk.
Examples of Personal Guarantee
Small Business Loans: Often, when a small business applies for a loan, the bank or financial institution may not consider the business itself as having a sufficient credit history or financial strength to support the loan. Therefore, they might ask for a personal guarantee from business owners or executives. As a result, the owner’s personal assets such as a home, car, or personal savings, would be at risk if the business were unable to repay the loan.
Rental Agreements: In certain instances, a landlord might require a personal guarantee from a leaseholder. For instance, if a person is starting a new business and wants to lease a space, the landlord might be uncertain about the business’s ability to maintain regular payments. Hence, they might require a personal guarantee from the new business owner, making the individual responsible for paying the rent even if the business fails.
Credit Cards: Some credit card companies require a personal guarantee, especially in case of business credit cards. If the cardholder cannot pay their debt, the credit card company can go after the guarantor’s personal assets to recover the money. This is common in startup companies where the business does not yet have a strong credit history, or in cases where the credit limit is particularly high.
Personal Guarantee FAQ
What is a Personal Guarantee?
A Personal Guarantee is a legal agreement where an individual commits to repay a debt in case of default by the primary debtor. This means, if a business owner uses a Personal Guarantee to acquire a loan and the business can’t make repayments, the owner is personally responsible for the debt.
What are the risks of a Personal Guarantee?
While a Personal Guarantee can help secure necessary financing, it also comes with risks. The main risk is that if the business defaults on the loan, the individual providing the guarantee is personally responsible for repaying the debt. This could mean the loss of personal assets or even bankruptcy.
Can you get out of a Personal Guarantee?
In most cases, a Personal Guarantee stays in effect until the loan is completely paid off. However, it’s sometimes possible to negotiate with the lender to modify or release a Personal Guarantee, particularly if business circumstances change significantly.
What does it mean to secure a loan with a Personal Guarantee?
Securing a loan with a Personal Guarantee means that the lender has a claim to the personal assets of the individual who signs the agreement. If the borrower defaults on the loan, the individual who signed the Personal Guarantee is held personally responsible for repaying the debt.
Related Entrepreneurship Terms
- Collateral
- Indemnity Agreement
- Creditor
- Joint and Several Liability
- Unsecured Debt
Sources for More Information
- Investopedia: In-depth, educational information on Personal Guarantees and many other financial topics.
- U.S. Small Business Administration (SBA): Offers a robust resource on financing for small business owners, including information on personal guarantees.
- Entrepreneur: Provides resources and articles for entrepreneurs, including information on Personal Guarantees.
- The Balance: Delivers personal finance advice and information, which often includes topics like Personal Guarantees.
