How to Secure Business Funding Without a Personal Guarantee
Business loan options that don’t require personal collateral
It’s easy to feel like you have to jump through endless hoops when you’re seeking a loan for your business. Even entrepreneurs with solid business ideas, good credit, and plenty of assets must prove to lenders that they’re a reasonable risk and will repay every penny they borrow.
Banks and other lenders protect themselves by requiring applicants to provide a personal guarantee on the money they borrow. A personal guarantee is essentially similar to providing collateral—only the collateral is your personal assets, not those of your business.
Although the majority of business loans include a provision for collateral, not all do. Getting a business loan without a personal guarantee is possible, but you should be aware of a few caveats.
What is a personal guarantee?
When you borrow money to launch or grow your business, you do so with the expectation that you’ll earn enough income to repay it.
Unfortunately, though, things can go wrong. Perhaps you lose a significant client, or sales don’t reach your projections. Whatever the reason, if you can’t repay the loan, it will go into default.
If this happens, and the loan includes a personal guarantee provision, the bank will expect you to repay it using your personal assets. These could mean anything from draining your personal bank account to liquidating your home. Small business lenders require these guarantees to reduce the risk of being left with a substantial write-off if your business underperforms.
Personal guarantees are legally binding. Most banks and other lenders, including the Small Business Administration, require them, even for applicants who exceed the minimum lending requirements. However, these agreements don’t require borrowers to put money in escrow or provide any other upfront payments, and the lender can only enforce it if the loan goes into default.
Types of personal guarantees
There are three distinct types of personal guarantees for business loans. The type you will sign depends on the lender’s policies, the structure of your business, and the strength of your application.
Unlimited personal guarantee
An unlimited personal guarantee puts you on the hook for the balance of the loan and any outstanding interest and late fees you owe. You may also have to cover the lender’s legal costs to collect the debt. If you are a sole proprietor (not a corporation or LLC), this may be the only option if you want to secure a loan from that lender.
Limited personal guarantee
Limited personal guarantees put a limit on how much of a defaulted loan you are personally responsible for repaying. If you and several business partners take out the loan together, the bank can divide responsibility based on your percentage of the business ownership. For example, if you have five partners, the bank will split the guarantee five ways, so you’re each only personally responsible for 20% of the loan balance.
Continuing personal guarantees
Continuing personal guarantees aren’t a different type of guarantee but rather an add-on to limited and unlimited guarantees. A continuing personal guarantee applies the agreement to all previous and future contracts with the lender without the need to sign an additional agreement. For example, suppose you take out another loan in two years. In that case, a continuing agreement stipulates that the terms of your existing personal guarantee will still apply, and you’re now personally responsible for repaying both loans.
Understanding the risks of a personal guarantee and why you might seek alternatives
From a borrower’s standpoint, the only reason to agree to a business loan that requires a personal guarantee is to secure funding. In many cases, the only way the lender will agree to issue the loan is if the borrower agrees to these terms. They solely protect the lender, reducing their risk of loss if you fail to repay your debt.
As the borrower, your risks are much higher when you agree to a personal guarantee. If you default and the lender has to enforce the contract, the results can devastate your business and personal finances. Consequences can include:
- Being forced to sell assets like your home or vehicle
- Wage garnishments
- Significant reduction in your credit score
- Inability to get future loans, including personal loans and mortgages
- Additional costs for attorneys and court fees
- Bankruptcy
Of course, if you repay the loan as agreed, you won’t risk default and these consequences. Still, if you are dead-set against securing financing with a personal guarantee, you can pursue alternative financing options.
Securing a business loan without a personal guarantee
Although most lenders require borrowers to sign a personal guarantee if they own at least 20% of the business, and doing so can mean a lower interest rate and more attractive terms, you can pursue less-risky alternatives.
Establish a corporation or limited liability company
If you operate your business as a sole proprietor, you’re out of luck when securing loans without a personal guarantee. Unless your business is a corporation or registered as an LLC, financial institutions consider all debt personal debt.
Therefore, to get a business loan without a personal guarantee, you must incorporate your company or set up an LLC and establish a financial history as that entity. All the business’s legal and financial documents and accounts must be in that name so you can demonstrate to a lender that it is stable and you can repay the debt.
Consider putting up business collateral
One of the most common methods of seeking business funding without a personal guarantee is to take out a secured loan, which requires collateral. For example, if you purchase equipment for your business, like a vehicle, that equipment can serve as collateral that the lender can seize if you default. In other cases, you may be able to negotiate loan terms that replace a personal guarantee with a portion of your business profits or other assets.
Demonstrate business stability and good credit
Getting an unsecured (i.e., no collateral) loan without a personal guarantee is possible. Doing so requires strategically building your business from the ground up with an eye toward stability and establishing exceptional credit. The better your company’s financial position, the more likely lenders and alternative financing providers will be willing to extend a loan with your business as the sole guarantor.
A solid credit rating
When you apply for a loan as a business, the lender will likely look at your business credit rating to determine whether you qualify for funding and how much, the interest rate, and the loan terms.
Lenders could pull a business credit report from an agency like Dun & Bradstreet to get a picture of your company’s payment history to existing creditors. The faster it pays debts, the higher the score, also known as the PAYDEX score.
Understanding your PAYDEX score can affect your overall credit status. PAYDEX scores are weighted averages, meaning that they consider the value of your debts. Paying high-value invoices or bills first will increase your PAYDEX score and put it into a range where you can seek a loan without a personal guarantee.
Positive payment history
A well-established track record of managing your debt, even with lenders that don’t require a PAYDEX score or credit history, can also help you get a business loan without a personal guarantee. Establish trade lines of credit with suppliers and make on-time payments to bolster your company’s overall creditworthiness and show lenders that your company is on solid financial footing.
The bottom line? When you want to avoid the requirement of a personal guarantee, you must create a business entirely separate from yourself. Hence, the ability to get money comes from its performance, not your personal credit and assets.
Evaluate other financing options
Traditional business loans may not be the best choice in every situation. Other financing options don’t always require a personal guarantee, like:
- Unsecured Term Loans
- Merchant cash advances, which provide a lump-sum payment based on your business’s daily sales
- Revenue-based loans
- Business lines of credit
- Business credit cards
- Crowdfunding
- Peer-to-peer lending
Credit lines and interest rates vary, but these may be viable alternatives to a traditional loan.
Get help exploring your options with Finance Factory
For almost 20 years, Finance Factory has been a reliable source of funding for startups and small businesses, connecting them with alternative financing options that allow them to bring their business dreams to life.
If you’re encountering roadblocks with traditional business lenders, get in touch with us today or fill out our quick, no-obligation pre-qualification form to learn how we can help you. There’s no impact on your credit, and you’ll see in just minutes how we can help you grow your company and put it on solid financial ground to meet—and exceed— even your loftiest goals.
