Business loans like commercial mortgages usually require a personal guarantee, especially if they are unsecured without collateral. But if you are hesitant to put your assets on the line for your business, there are not many options.
The good thing is that there are a few lines of credit and business that you can apply without a personal guarantee. And though these loans have higher interest rates than loans secured by collateral or your assets, it can be worth it to spare yourself the anxiety of losing your assets.
Before we go there, it is important to know more about personal guarantees and why lenders require them before giving you a loan. This article will provide you with all you need to know about personal guarantee loan agreements.
What is a personal guarantee loan agreement?
Business owners, especially small business owners, can be put under a considerable burden to give personal guarantees to start their new business or secure essential funding for an already established business.
In most cases, lenders will only be willing to issue a loan if a personal guarantee supports the company’s obligations from one or more of the individuals who own it. But, however tempting it may be to be excited about the business’s projected success, it is a fact that thousands of businesses fail each year. Thus, business owners should never think that failing to pay a loan or insolvency is not possible.
A personal guarantee loan agreement, also known as joint-and-several liability, essentially makes you a co-signer to your business on loan. This means that if your company defaults on loan payments, you are legally liable to make payments.
If, however, you are unable to pay, the lender can claim your assets, such as your house, car, or investments, for repayment.
Depending on the lender and type of loan your business is applying for, you may be obliged to sign an unlimited or limited personal guarantee loan agreement. With an absolute personal guarantee loan agreement, you agree to be liable for paying the entire amount of the loan’s principal and interest if your business could not. This is typically always the type of guarantee you’ll sign if you’re the sole owner of your business.
A limited guarantee loan agreement, on the other hand, is common with partnerships, corporations, or limited liability companies, which have multiple owners. Each owner or partner is assigned an agreed percentage of the debt. Then, your liability is only limited to your share. However, in some cases, the lender may include a clause in the loan agreement to convert a limited guarantee to an unlimited personal contract. The conversion is usually contingent on certain negative actions, such as missing payments on the loan or falling behind on your business tax payments.
Why do business lenders require a personal guarantee loan agreement?
Lending to small businesses is a risky matter. Because of this, most business lenders have minimum requirements for revenue and time in business and the addition of collateral.
However, with unsecured loans without collateral, the lender needs some form of assurance that it will get its money back if your business cannot pay your loan. That assurance comes in the form of a personal guarantee loan agreement. Personal guarantees are the basic standard for most business loans, and they are a form of protection for lenders.
How to secure business loans without a personal guarantee loan agreement?
It is nearly impossible for businesses, especially brand new companies, to obtain a business loan without a personal guarantee. But suppose you plan for it from the start. In that case, you can build your business credit fairly quickly and possibly eliminate the need for personal security for an expansion loan once your business is up and running.
First, you need to make sure that your business is properly set up right the first time. It would help if your business were registered as either incorporated or a limited liability company to build business credit. Otherwise, lenders will consider your loan as a personal loan. Personal loans have higher interest rates compared to business loans (up to 10 percent higher).
Second, you need to build up your credit history with successful payments. Today, the most common credit rating service in business is Dun & Bradstreet (D&B). D&B makes a report that contains your company’s history of payments to all of your creditors. Depending on how fast you pay off your invoices, your D&B report will result in a high, good rating, or a low, bad rating.
This rating is referred to as your “paydex” score and is the best measurement of your company’s ability to pay bills. Banks and other businesses use this rating to determine your interest rates on loans, the amount of credit, the terms they grant your business, and ultimately help them decide whether to allow you to loan with a personal guarantee.
Next, understand that the “paydex” score is based on a weighted average. This means that your company’s highest valued invoices, payments, or bills carry the most weight in your paydex score.
Thus, in paying off your invoices, make sure to pay the highest values first. This will make sure your paydex score is within an acceptable range. Remember, having a high paydex score will help your business get those lower interest rates on loans, making sure to maintain a high or an acceptable score.
Lastly, establish credit with suppliers that do not require a “paydex” score or a personal guarantee. Several business suppliers, particularly office supply and industrial supply companies, do not need a paydex score or private security to build credit terms with them. These companies may require your first batch of orders to be paid in advance, and they may start you off with a fairly low credit limit, but you can build higher credit limits and longer terms with them over time.
Are there business loans with no required personal guarantee loan agreement?
Business loans with no personal guarantee loan agreement requirement are very rare, but they do exist.
Getting access to a business loan with no personal guarantee is very difficult. Some rare business loans do not require an individual contract, but even then, the lender’s short repayment terms and lack of a true business loan could make it difficult to use for some businesses.
You can also start building up your business credit scores by paying your creditors on time and increase your paydex score. But this method is only possible for companies that are already up and running and not for new businesses.
Because of this, it is worth considering other lenders that do require a personal guarantee. If you do, be sure to have a concrete business plan and avoid borrowing more than you can personally repay if the business does not work out.
While that might be intimidating, loans that require a personal guarantee can provide you with the resources you need to start a new business or take your current business to the next level.
For More Information, Contact:
John (Adam) Watson, CEO, CanCap Mortgage Group Inc.
Email: firstname.lastname@example.org Tel: 416-452-5281