Personal Guarantee

A personal guarantee is a contract in which an individual, usually an owner of the borrowing business, promises a lender that they will personally satisfy the business's obligation if the business fails to. It exists because of the liability shield: an LLC or a corporation is a separate legal person whose debts are its own, so a lender extending credit to a young or thinly capitalized company is looking at whatever the company itself owns and not much else. The guarantee is the lender's answer. It does not take the shield away, and the business's other creditors get no benefit from it. It simply adds a second person to this particular debt, one whose house, savings and investment accounts are inside the lender's reach. (The general legal structure of a guaranty, and how it differs from cosigning, belong to our guarantor page; this one is about what signing does to a business owner.)

The terms are where the exposure is decided, and "personal guarantee" describes a range rather than a single document. An unlimited guarantee makes the guarantor answerable for the whole obligation, usually including interest, late charges and the lender's costs of collection. A limited guarantee caps exposure, either at a dollar figure or at a stated percentage, which is the common arrangement when several owners each guarantee a share. A continuing guarantee is the one to read closely: it covers not just the loan in front of the borrower today but future advances, renewals and modifications, and it stays alive until revoked in the manner the document specifies. An owner who signed for a $75,000 equipment loan in year one can be standing behind a $400,000 line of credit in year six without ever signing again. Where more than one owner signs, joint and several liability is the default drafting, so the lender may collect the entire balance from whichever guarantor is most collectible and leave that person to chase the others for contribution.

A few lenders are required to ask. The Small Business Administration's loan conditions, which it states are normally required for all its business loans, provide that holders of at least a 20 percent ownership interest generally must guarantee the loan, which is why SBA borrowers rarely negotiate the question at all; our SBA loan page covers how those programs work. No comparable rule reaches conventional bank lending, where whether a guarantee is required, and on what terms, is an underwriting judgment that varies by lender, by the borrower's history and by how much collateral is on the table.

Regulation B limits who can be made to sign. A creditor may decide that the personal liability of an additional party is necessary to support the credit requested, and may then "request a cosigner, guarantor, endorser, or similar party" — but the same rule says "the creditor shall not require that the spouse be the additional party." And where the applicant already qualifies under the creditor's own standards of creditworthiness for the amount and terms requested, a creditor "shall not require the signature of an applicant's spouse or other person, other than a joint applicant, on any credit instrument" at all. These rules apply to business credit as well as consumer credit, and the practical effect for a married owner is that a lender may ask the spouse to guarantee, and may condition the loan on someone guaranteeing, but may not insist that the someone be the spouse. Narrower provisions let a creditor reach jointly owned or community property where state law makes that necessary to collect.

On default the guarantee turns into an ordinary debt collection against an individual. If the loan was secured, the lender typically liquidates the collateral first and pursues the guarantor for the shortfall, but what the lender must do before coming to the guarantor is a matter of the guaranty's own wording and of state law rather than a general rule, and many guarantees are drafted to waive those steps expressly. What is clear is the bankruptcy answer. If the business files and its debt is discharged, section 524(e) of the Bankruptcy Code provides that "discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt." The guarantor's promise is a separate obligation, so it survives the borrower's discharge untouched. A guarantor seeking relief has to seek it for themselves.

That makes the terms worth negotiating before signing rather than after. The points that move in practice are a dollar cap; several rather than joint liability where several owners sign, so each stands behind a stated share; a burn-off, under which the guarantee shrinks or falls away once the business meets agreed measures such as a debt service coverage ratio maintained over a period; a carve-out of specified personal assets; and a written release triggered by refinancing or by paying the balance below a threshold. None of these is automatic, and the one rule that applies to all of them is that a release has to be in writing and signed by the lender. A guarantee that is simply no longer discussed is still a guarantee.

1. The business applies for credit and the lender concludes the business's own assets and history do not support the amount requested on their own.

2. The lender asks one or more owners to guarantee it. For an SBA-backed loan this is close to automatic for holders of at least a 20 percent interest; for conventional credit it is negotiable.

3. The owner signs a separate guaranty document, which is not the loan agreement. Its scope, its cap if any, whether it is continuing, and what it takes to revoke it are all set in that document.

4. The business pays as agreed and nothing happens. A guarantee is contingent, and most are never called.

5. If the business defaults, the lender realizes on any collateral and looks to the guarantor for what remains, following whatever the guaranty and state law require of it first.

6. A business bankruptcy does not end the guarantee, because the guarantor's obligation is separate from the discharged business debt.

Consider an example. An LLC borrows $200,000 to buy equipment, secured by the equipment, and its sole owner signs an unlimited personal guarantee. Three years later the business fails with $140,000 still outstanding. The lender repossesses and sells the equipment for $85,000, leaving a deficiency of $140,000 − $85,000 = $55,000, plus accrued interest and collection costs. The LLC has no other assets, and its own liability ends there. The owner's does not: the $55,000 is enforceable against her personally, and it would remain so even if the LLC filed for bankruptcy and had the debt discharged. Had she negotiated a guarantee capped at $25,000, the lender's claim against her would stop at that figure and the remaining $30,000 would be the lender's loss.

Pros

• It is often what makes the credit available at all. A business without a long operating history or substantial assets may have no other way to borrow at a reasonable rate.
• Adding the owner's credit standing to the file can lower the rate, raise the amount, or both, because the lender's expected loss falls.
• The terms are negotiable in conventional lending. A cap, a several-liability split or a burn-off are ordinary requests, not exotic ones.
• It leaves the entity intact. The guarantee binds the owner on one debt and does nothing to the liability shield as against everyone else.

Cons

• It puts personal assets behind a business risk, which is the exact exposure forming an entity was meant to avoid.
• A continuing guarantee can outgrow the loan it was signed for, covering renewals and future advances until it is formally revoked.
• Joint and several liability means one owner can be pursued for the entire balance, with only a contribution claim against partners who may be broke.
• The business's bankruptcy does not clear it, so an owner can lose the business and still owe the debt.
• Releasing it is the lender's decision, not an event that happens automatically when the business improves, and it has to be documented.