Why does the Bank require a Personal Guarantee?
What is a Personal Guarantee? A Personal Guarantee is an agreement that makes one liable for one's own or a third party's debts or obligations. A personal guarantee signifies that the lender (oblige) can lay claim to the guarantor's assets in case of the borrower (obligor) default.
With a Personal Guarantee, the business owners (or whoever else guaranteed the loan) sign an agreement saying they are personally responsible for repayment. Even if the Small Business is incorporated to limit personal liability, the Guarantor is personally tied to the loan they have guaranteed.
From the Bank's perspective, the Bank seeks to identify at least three sources of repayment. The primary source of repayment is generally how the Bank will get paid in the normal course of events – cash flow from the business. The secondary source of repayment is any collateral that has been pledged for the loan. The third source of repayment – if needed – is generally the owner's personal net worth, which the Bank looks to cover any shortfall should the primary and secondary sources or repayment fail to pay off the loan. If the borrower makes it loan payments as required under the loan, there is not reason for the Bank to pursue enforcement of the Guaranty.
Why does the Bank require a Personal Guarantee on Small Business Loans?
- The Bank uses their Customers' deposits to make Small Business (and other) loans, and as a result the Bank is responsible for protecting the interests of their depositors.
- A Personal Guarantee shows your commitment to being a responsible business manager and repaying their loan.
- Financial affairs of a Small Business are commonly intertwined with the personal affairs of its owners, so the Bank asks you to promise to personally repay if the business cannot. It acts like an insurance policy – if your business doesn’t pay, you will pay.
- A Personal Guarantee offers the Bank the ability to follow the due process to recover repayment of the business loan from you personally.
Typically the Bank requires a Personal Guarantee of any 20% or greater shareholder in the business.
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