What is a personal guarantee on a business loan, and can it be limited?

What a guarantee actually commits you to

A business loan is the company's debt. A personal guarantee turns it into the owner's debt too. If the business defaults, the lender can pursue the guarantor directly, usually without first exhausting the collateral, because most guarantees are written as guarantees of payment, not merely of collection. The lender can sue, obtain a judgment and collect from the owner's personal assets, subject to the exemptions the owner's state allows.

Three features of the standard bank form are worth knowing before signing:

• Joint and several. Where there are several guarantors, the lender can usually collect the whole debt from any one of them, leaving them to sort out contribution among themselves. A minority owner with the deepest pockets may end up paying the most.
• Continuing. Many guarantees cover all of the business's obligations to the lender, now and in the future, not just the loan being signed for. A guarantee signed for a term loan can quietly cover a later line of credit. It lasts until revoked in writing for future debts, and revocation does not cover what is already owed.
• Waivers. Guarantees typically waive defenses a guarantor might otherwise raise, such as the lender releasing collateral or extending the loan without the guarantor's consent.

A guarantee is a separate contract from the loan and from the lien on business assets. It does not end when a UCC filing is terminated; it ends when the lender releases it. See getting a guarantee released at refinance.

The kinds of guarantee

For a fuller side-by-side, see limited versus unlimited personal guarantees.

Bank, SBA and private credit practice

How much of a guarantee can be negotiated depends mostly on the lender's model.

SBA loans. Every owner of 20% or more personally guarantees an SBA loan, and SBA's rules call for that guarantee to be full and unlimited. The lender may ask others to guarantee as well, sometimes on a limited basis, such as owners below the threshold or a key manager. When the business's assets do not fully secure the loan, the lender may also take a lien on personal real estate. There is little to negotiate on an SBA guarantee; the room is in the structure around it. See SBA's 20 percent owner guarantee.

Banks. Conventional bank loans to owner-operated businesses almost always carry a full guarantee from the principal owners. A bank's credit policy treats the guarantee as a secondary source of repayment and as proof of commitment. Room to limit it comes with a long relationship, low leverage and strong collateral coverage, and even then banks more often agree to a burn-off than to a cap at closing.

Asset-based lenders. Because the loan is sized on receivables and inventory and policed through a borrowing base, many asset-based lenders accept a validity guarantee: the owner is liable if the borrowing base was misstated or collections were diverted, not for an ordinary shortfall. See personal guarantees on lines of credit.

Private credit. Private credit funds lend against cash flow and enterprise value, and structure their protection through covenants, equity in the deal and control rights. They often ask for less than a bank: a limited or validity guarantee, and in sponsor-backed deals frequently no personal guarantee at all. The trade is usually cost: private credit is typically priced above bank debt. See how private credit is priced and moving from a bank to private credit.

The biggest lever on a guarantee is choosing the lender, not arguing with it. A bank's form is a policy; a private credit term is a negotiation.

Burn-offs and other ways to limit it later

Where a lender will not cap the guarantee at closing, it may agree to reduce or release it once the loan has proved itself. Common triggers:

• Leverage. Release when total leverage falls below an agreed level for a set number of consecutive quarters.
• Coverage. Release when debt service coverage stays above an agreed level.
• Paydown. The guarantee steps down as principal is repaid, or ends once the balance falls below a set amount.
• Clean history. Release after a period of on-time payments with no covenant breaches.

A burn-off should be written into the loan documents with objective tests and an automatic release, not left as a promise to consider it later. An SBA lender cannot offer a burn-off on the guarantee SBA requires from a 20% owner; that requirement is a program rule, not the lender's choice. On a conventional loan, refinancing once the business has deleveraged is often the cleanest way out of a guarantee.

Guarantees in acquisitions, and for spouses

In an acquisition, the buyer guarantees; the seller's old guarantees on the business's debt should be released at closing as that debt is paid off. On an SBA 7(a) acquisition loan, every buyer who will own 20% or more of the business guarantees it. A buyer using a holding company still guarantees personally; the holding company typically guarantees too. See personal guarantees on acquisition loans.

Spouses are a separate question. Federal fair lending rules generally prevent a lender from requiring a spouse's guarantee just because the applicant is married, but a spouse who is an owner, or whose jointly held property is pledged, may be asked to sign. See when a spouse must guarantee.

When Transparent takes a file to market, the guarantee each lender would expect is part of what separates one term sheet from another, alongside rate, leverage and covenants. The lender package lays out the ownership and each owner's personal financial statement, where the lender type calls for one, so lenders can say what they require up front. See how we underwrite.