The process of the loan application can be tiring. It involves lots of financial records and paperwork to show you have a sound investment. A lot of lenders, whether an online lender, an insurer or a bank want to know that you will put their money to good use and pay them back on the agreed day between yourself and the bank. When looking for a loan, financing for equipment, or a line of credit, most entrepreneurs get shocked when they learn that they will require a guarantee to secure the money.
While applying for a loan, you might be very optimistic – which is the right thing to do. Trying to get financial assistance without feeling positive about the potential of the money to help your company could land you in a disaster, particularly if the loan application deals with a guarantee. There is nothing wrong with signing a personal guarantee; it has become a standard in financing most businesses.
What is a Personal Guarantee?
Essentially, it is a promise made legally by a business owner that he or she will repay out outstanding debts owed by the business if the business fails to pay it is seen as a legal clause meant to protect lenders. Anybody that signs a personal guarantee will, in the long run, be putting their financial future and that of their families at risk. So, before going into this agreement, understand what you are getting yourself into.
Types of Personal Guarantees:
There are two different types of personal guarantees which include unlimited and limited personal guarantees.
Unlimited
With this type of personal guarantee, you are allowed to authorize the lender to get 100 per cent of the loan collected. In addition, to the other legal fees that are involved. If you fail to pay the loan or your business fails, the lender can get lawyers to have a judgment allowing them to go after your retirement savings, the college fund of your kids, your assets or your life savings, so they can recover the full amount collected.
Limited
A limited personal guarantee allows the lender and borrower agree on a particular limit. If you fail to pay back the loan, you will only be held accountable for the predetermined amount. This kind of personal guarantee is mostly used by a business that has multiple owners that need to take a loan.
The Consequences to Consider:
Standing in as a guarantor for getting a loan can lead to great burden for not just the guarantor, but also their family members. Although it is advisable to get indemnification from the organization that the guarantor is signing for, in an instance where the guarantor is needed to pay a defaulted loan, he or she may encounter some difficulties.
For instance, things that contribute to a default – such as financial difficulties or poor business performance, can probably lead to a delay in repayment or in some cases, cause the company to be unable to pay back the guarantor at all.
Another risk is that the person signing the personal guarantee form may pass away. When this happens, the interest of the lender will become a priority to the family of the deceased.
How to Reduce these Risks
There are some things a person can do to lower the risks involved with signing personal guarantee insurance, some include:
• Have a key person life insurance for the individual standing in for the company. If the person that signs the unenforceable personal guarantee form passes away, the insurance plan should be able to ease the burden of the deceased family in paying the debt.
• When multiple guarantors are involved, forms of liability should be used. Avoid using several and joint liability as a guarantor. When you use this term, only one person will be left with the burden of paying the debt, rather than it being shared among all co-guarantors equally.
• Try to negotiate a termination date with the lender – the date will determine when the guarantee will no longer be viable.
The Bottom Line
Before agreeing to any kind of guarantee, objectively consider the business and finances; understand the probability that no matter how hard you try, you might not be able to pay off. But just because signing a personal guarantee has risk, this does not mean that there are not rewards.
