Understanding Guarantees in Business Loan Agreements
When you apply for a small business loan, the focus is often on securing the best rates and terms, and simply getting approved can feel like a major victory. However, amidst the relief and excitement, it’s crucial to carefully review Business Loan Agreements, especially if they include a personal guarantee. Understanding the implications of these Business Loan Agreements is essential before signing, particularly in the context of the lending industry.
Collateral vs. Guarantee
Collateral refers to assets pledged to secure a business loan agreement, such as a vehicle for an auto loan or a house for a mortgage. While small business loan agreements can be secured by collateral, a guarantee is different. It ensures a specific outcome, like repayment within a set period. The most common type in small business lending agreements is a personal guarantee, but there are others like validity and performance guarantees.
Personal Guarantee
Many Business Loan Agreements require a personal guarantee, especially for unsecured loans. By signing these Business Loan Agreements, you agree to be personally liable if the business defaults, allowing the lender to seek repayment from your personal assets. This clause in Business Loan Agreements can override the protection offered by business structures like LLCs or S-Corps.
Types of Personal Guarantees
Unlimited Guarantees: You are 100% responsible for the loan, including fees and legal costs, putting personal assets like your home or retirement accounts at risk.
Limited Guarantees: Shared among multiple business owners, either by predetermined amounts or jointly and severally, meaning you could be liable for the entire debt if partners default.
“Bad Boy” Guarantees: Convert a limited guarantee into an unlimited one if triggered by specific actions, such as committing fraud or failing to pay taxes.
Confession of Judgment
Business Loan Agreements are not a guarantee per se but are often paired with personal guarantees. These agreements allow the lender to bypass the court system to collect on a defaulted guarantee. Signing a Business Loan Agreement means waiving your right to a trial or hearing, making it easier for the lender to enforce repayment.
Other Types of Guarantees
Performance Guarantee
Common in construction loans, it ensures that specific performance milestones are met, or the contractor pays a penalty. In small business loans, it could apply to merchant cash advances repaid through credit card transactions.
Validity Guarantee
Often required for invoice factoring, it guarantees that the pledged invoices are valid, collectible, and not promised to another company. It also requires you to forward any misdirected payments to the factoring company.
UCC-Lien
A UCC-lien, stemming from the guarantees on your loan, establishes a priority claim on your assets if you default or file bankruptcy. It’s a common practice and should not be a cause for concern if payments are made as agreed. However, outstanding UCC-liens can complicate obtaining additional financing.
Consequences of Violating a Guarantee
Defaulting on a guarantee can have severe consequences. With a personal guarantee, any personal asset could be at risk, including your home and retirement accounts. In cases involving business partners, poor financial management by one can affect the other. Always understand the financial responsibility and capability of your partners.
Conclusion
Signing a guarantee has significant implications. It’s vital to fully comprehend these before committing. Discuss any questions with your lender and lawyer to ensure you understand the commitments involved in taking out a business loan. Reputable lenders will help clarify these terms to ensure informed decision-making.