The personal guarantee

The short version

• A personal guarantee is your promise to repay the business loan yourself if the business cannot.
• For an SBA loan, anyone who owns 20 percent or more of the buying company must sign an unlimited personal guarantee. It is not negotiable.
• If business assets do not fully secure the loan, the lender must take a claim on equity in your personal real estate, often including your home.
• You can reduce what is at risk, mostly by reducing how much you borrow under that guarantee.
• Understand it fully, with your M&A attorney, before you sign anything.

What it means

Most buyers form a company, often an LLC, to own the business they buy. Normally, a company's debts are its own. A personal guarantee changes that for the loan. If the business stops paying and selling its assets does not cover what is owed, the lender can come to you personally for the rest.

That can include your savings, investments and other property.

The SBA rule

For loans guaranteed by the U.S. Small Business Administration, every person who owns 20 percent or more of the borrowing company must give an unlimited personal guarantee. Unlimited means there is no cap: it covers the full loan, interest and collection costs.

A few related points:

• Spouses. If spouses together own 20 percent or more, both must guarantee the loan, even if each owns less.
• Owners under 20 percent are not required to guarantee by the SBA, but a lender can still ask.
• It lasts for the life of the loan, until it is repaid.

Your home and other personal property

SBA lenders are expected to take available collateral. If business assets do not fully secure the loan, the lender must take a claim on the equity in personal real estate owned by anyone with 20 percent or more of the company, including your home.

Two limits apply:

• Under 25 percent equity. The lender does not have to take a claim when your equity is less than 25 percent of the property's value.
• A cap on the claim. The claim can be limited to the shortfall in collateral, or to 150 percent of your equity in the property.

A spouse who co-owns the home will need to sign the collateral documents, even if they do not own part of the business. Their responsibility is limited to their share of that property.

Ask any lender exactly what collateral they will require before you apply.

What you can and cannot change

You cannot remove the guarantee on an SBA loan if you own 20 percent or more.

You can reduce what is at risk:

• Borrow less under the guarantee. A larger down payment, a note from the seller or part of the price financed another way all shrink the amount you personally stand behind.
• Negotiate collateral. Ask whether a claim on your home is needed, and whether it can be capped at the shortfall.
• Consider conventional loans. Without an SBA guarantee, some lenders accept a limited guarantee, a cap on how much you owe, or one that ends after a period of good payment. These terms are set by each lender.
• Plan for the unexpected. If the loan is not fully secured and the business depends on you, life insurance on you is required. Lesson 8.4 covers this.

Talk about it at home

A personal guarantee affects your household, not just you. Talk it through with your spouse or partner before you sign a letter of intent, not at the closing table.