Why a Personal Guarantee is a Risky Proposition for Small Business Owners

When starting a small business, entrepreneurs often need additional financing to get the company off the ground. One of the most common ways to obtain such financing is to borrow money from a bank or other lender. However, lenders may require the small business owner to provide a personal guarantee as a condition of the loan.

A personal guarantee is a legally binding agreement in which the business owner agrees to be personally liable for the repayment of the loan. In other words, if the business is unable to repay the loan, the lender can come after the business owner’s personal assets, including their home, car, and savings accounts, to satisfy the debt.

While personal guarantees can make it easier for small businesses to secure financing, they also come with significant risks. Here are a few reasons why a personal guarantee is a risky proposition for small business owners.

1. Personal liability: As previously mentioned, a personal guarantee makes the business owner personally liable for the repayment of the loan. This means that if the business is unable to repay the loan, the owner’s personal assets may be seized to satisfy the debt.

2. Limited liability protection: One of the main reasons entrepreneurs choose to form a limited liability company (LLC) or corporation is to protect their personal assets from business debts and liabilities. However, by signing a personal guarantee, the owner may be waiving this protection and exposing themselves to personal liability.

3. Unforeseen circumstances: No one can predict the future, and unforeseen circumstances such as a global pandemic or economic recession can cause even the most successful businesses to struggle financially. If the business is unable to repay the loan, the owner’s personal finances may suffer as a result.

4. Difficulty getting future financing: If a small business owner has signed a personal guarantee for one loan and struggles to repay it, they may have a difficult time obtaining financing in the future. Other lenders may be hesitant to work with someone who has a history of struggling with debt repayment.

5. Psychological burden: Finally, a personal guarantee can add a significant psychological burden to the small business owner. Knowing that their personal assets are on the line can cause stress and anxiety, and may even negatively impact their ability to run the business effectively.

Given these risks, small business owners should carefully consider whether or not to sign a personal guarantee when obtaining financing. While it may be necessary in some cases, it should always be approached with caution and a full understanding of the potential consequences. Alternatives to personal guarantees include finding a co-signer, offering collateral, or seeking financing from alternative lenders. By exploring these options, small business owners may be able to secure financing without putting their personal assets at risk.