Personal Guarantees: A Quick Guide for Business Loans

When securing a small business loan, the focus often centers on obtaining the best rates and terms while grappling with the possibility of loan rejection. Once approved, the relief and excitement can be overwhelming. 

However, as you review your loan agreement, you may encounter personal guarantees. This is a standard feature in many small business loans in California and is not necessarily cause for alarm. It is crucial to understand the implications of this guarantee and how it may affect your future before signing the agreement.

Is a Guarantee the Same as Collateral?

Collateral refers to assets pledged to secure a business loan, such as a vehicle for an auto loan or a house for a mortgage. Small business loans may also be secured with collateral, which could include Personal Guarantees or business assets. 

Collateral is different from a guarantee, which ensures a specific outcome, such as timely repayment. The most common guarantee in small business lending is a personal guarantees, though other types such as validity or performance guarantees may also be involved.

Types of Personal Guarantees

Unlimited Guarantees:

An unlimited personal guarantees makes you fully responsible for the loan. Should the business default, the lender can pursue repayment from your personal assets, including your home, retirement accounts, or savings. 

This type of guarantee includes the obligation to cover not only the loan balance and interest but also any fees or legal costs incurred by the lender.

Limited Guarantees:

A limited guarantee divides the debt among multiple business owners. There are two main types:

• Several Limited Guarantee: Debt is split equally or according to a predetermined ratio among business owners. For instance, in a 50/50 ownership structure, each owner would be responsible for half the debt.

• Joint and Several Guarantee: Each partner is responsible for a portion of the debt but may be held fully accountable if the other partners default.

“Bad Boy” Guarantee

A “bad boy” guarantee turns a limited guarantee into an unlimited guarantee if specific behaviors trigger it. Triggers can include fraud, unpaid expenses leading to liens, unpaid taxes, or bankruptcy. This guarantee provides additional protection for the lender.

Confession of Judgment:

A confession of judgment often accompanies a personal guarantees to facilitate easier collection if a borrower defaults. By signing, you waive your right to a trial or defense in court. 

The lender can file the confession of judgment directly with the county clerk or agency, making it challenging for you to contest the judgment. This type of guarantee is not legal in all states and can significantly limit your ability to dispute collection efforts.

Performance Guarantee

Common in construction financing, a performance guarantee ensures the lender is protected if a contractor fails to meet contract milestones. In small business loans, this type of guarantee is less common but may be required if loan repayment is tied to performance metrics, such as sales figures in merchant cash advances.

Validity Guarantee:

When working with an invoice factoring company, a validity guarantee may be required. This guarantee assures that the invoices pledged are valid, unclaimed by another company, and collectible. It also commits you to forward any misdirected payments to the factoring company. This can sometimes replace a personal guarantees, reducing the risk to your assets.

UCC-Lien:

While not a guarantee, a UCC lien (under the U.S. Uniform Commercial Code) establishes a priority claim on your assets in the event of default or bankruptcy. The lender files a UCC financing statement, making their lien a matter of public record. 

While common and generally not problematic if payments are made on time, a UCC lien could hinder future financing. Ensure that the termination statement is filed once the loan is repaid to avoid complications with future capital access.

Consequences of Violating a Guarantee:

Violating a guarantee can have serious consequences, varying by the type of guarantee signed. With a personal guarantee, almost any personal asset is at risk, including your home, car, retirement accounts, and bank balances. Even if your business is an LLC, a personal guarantee can nullify the protection usually offered by such business structures. Additionally, if you signed a limited or “bad boy” guarantee, you might be held responsible for your business partner’s financial mismanagement.

Before signing any legal documents, it’s essential to understand their implications. If you have concerns about the guarantees in your business loan agreement, consult with your lender and lawyer to ensure you fully comprehend your commitments. Reputable lenders will be willing to clarify any aspects of the agreement to ensure you are well-informed.