All You Need to Know About Personal Guarantees for Loans
If you recently started a business, you might need a loan to get it off the ground and pay for important start-up expenses. But you’ve probably quickly noticed that it’s hard for new and small businesses to get traditional loans from financial institutions. Does this mean that such enterprises can’t obtain any type of financing at all?
Thankfully, the answer to that question is “no”.
Signing a personal guarantee is one way that businesses can get loans if they don’t qualify for traditional financing. In this quick guide, we’ll explain everything you need to know about personal guarantees so that you can decide whether it’s right for you. We’ll discuss what they are and when they’re used. As well as the two types of personal guarantees, why they’re necessary, and what it means for you as a business owner to sign one.
What Is a Personal Guarantee?
A personal guarantee is a person’s legal promise to repay credit issued to his or her business. Personal guarantees are most popular with new and small businesses that don’t qualify for conventional bank loans due to their young age and short/inexistent credit history.
When you sign a personal guarantee, it means that you assume personal responsibility for the outstanding balance if your business defaults on the debt. Personal guarantees act as an extra layer of legal protection that ensures that credit issuers will be repaid for the money that they loan to businesses. When you assume personal responsibility, this allows credit issuers to collect your debt in the form of your assets if you fail to repay the loan.
What Are the Different Types of Personal Guarantees?
There are two types of personal guarantees: unlimited and limited guarantees. Unlimited personal guarantees allow the lender to recover the full amount of the debt (including related costs) by obtaining your assets. This means that if for some reason you don’t have enough cash to pay off the loan, the lender can seize your personal belongings and other assets until it has recouped the full amount.
Limited personal guarantees only allow the lender to collect a certain amount of money or a certain percentage of the outstanding balance if you default on the loan.
For example, you could be liable for only 35% of the loan balance in case of default. This percentage or amount must, of course, be specified in the loan documents before the funds are disbursed.
Why Are Personal Guarantees Necessary?
There are five key factors that explain why personal guarantees are so important and necessary when credit issuers loan money to businesses. First of all, credit issuers normally use your business’s credit history to judge its creditworthiness. However, since new/small businesses often don’t have this, a personal guarantee acts as a useful substitute for this.
Second, Singapore allows individuals to create companies with limited liabilities, which means that the owners are not personally liable for any business debts.
Third, small and medium-sized enterprises (SMEs) under a certain size are exempt from providing audited financial statements, which makes it harder for financial institutions to verify a business’s financial state.
Fourth, Singapore doesn’t have a mandatory, centralised SME Credit Bureau that evaluates and verifies the credit ratings of SMEs.
Lastly, lenders need to minimise the risk of losing the money that they loan, which means that your handshake and verbal promise to repay the loan isn’t enough for them. The inability to verify your credit rating or financial statements (especially for start-ups that do not have a lengthy credit history) increases their risk and forces them to find a different mechanism to reduce this risk. As mentioned earlier, a personal guarantee is an important legal assurance that they’ll get their money back no matter what happens.
What Does Signing a Personal Guarantee Mean for Business Owners?
Personal guarantees encourage business owners and company directors to borrow funds strictly for business purposes and use them responsibly given that they’re personally liable for them. Moreover, it increases their incentive to work hard to both repay the loan and use it to increase the financial success of their enterprise.
Most importantly though, signing a personal guarantee means that business owners have some “skin in the game” when they borrow money. It’s a huge and extremely serious commitment that says that you, the individual, are legally required to repay the loan no matter what happens. This includes possibly relinquishing your personal possessions in case you can’t come up with enough cash to pay off the loan.
As a result, even though signing a personal guarantee is a great way to obtain a loan, you need to understand that doing this means that you’re putting yourself and your family’s financial future at serious risk while doing so, therefore it is important to be weary of the terms and conditions stated in the personal guarantees.
Sprout with Us!
Providing lenders with a personal guarantee is a useful way to obtain financing for your business that you might not otherwise qualify for. Despite their usefulness though, we recommend connecting with a corporate secretary to further understands the terms and conditions of your personal guarantee for your loan. Sprout offers budget-friendly corporate secretarial services for companies just like yours! Additionally, we also work closely with bankers and Sprout is happy to ease the process by linking our clients with them to set up corporate accounts. Feel free to contact us with your queries, we’ll respond within 24 hours.