Small Business Loans: How to Handle Personal Guarantee Negotiations

For small business owners, signing a personal guarantee has become standard practice in the commercial loan approval process. While this is often the price of doing business, what does a personal guarantee (PG) really mean?

The proceeds of commercial loans may be used to fund large capital expenditures and operations that your small business may otherwise be unable to afford. Moreover, when applying for a business loan, a personal guarantee (PG) gives the bank permission to go after personal assets should your business default on the loan.

In addition to letting lenders pursue personal assets, many allow the PG to be called for things like technical default, additional borrowings, a sale of assets, death, or incapacitation. Some even allow the lender to obtain additional collateral on demand if the lender determines the loan to be undersecured.

In the case of a partnership, the most common form is a “joint and several” guarantee. This means the lender doesn’t have to pursue the personal assets of each partner equally, but is free to pursue those with the largest, most liquid assets. This puts some of the partners at a greater risk of loss and may require them to pursue claims against the other partners – who are often family or friends.

Contrary to popular belief, the legal benefits of incorporation will not protect business owners from a PG. By signing a PG, guarantors give the lender permission to pierce the corporate veil and gain access to savings accounts, cars, and property – including your family home.

Understanding Personal Guarantee Negotiations

As a small business owner it is important to understand not only what a PG is and does, but how you can successfully navigate the murky waters of PG negotiation.

1. How much risk can you accept?

First you should know your risk tolerance – both business and personal – before talking to a bank. This will greatly affect the amount and type of loan you should seek.

There’s the basic calculation of what would be required should the PG be called. Here’s where your accountant can add value by helping you evaluate your company’s liquidation value, taking into account any existing liens and the priority of repayment in case of bankruptcy.

Once this is done, you should consider the amount of personal assets you can risk on the business loan, including your equity in the business. What is an acceptable amount to gamble? The answer may be nothing – but whatever the number, it should be figured into the initial loan negotiation.

The basic equation should be:

Liquidation value of the business + acceptable personal risk > personal guarantee

Also be sure that your accountant considers factors beyond personal finance when they calculate your personal risk figure. For instance, if you have a spouse who will lose sleep at night or children about to enter college, the PG could dramatically affect your personal life. These issues should be discussed openly.