It’s a common scenario: You have a thriving business, and it’s doing so well that you believe it’s time to expand. That expansion requires more money, and, of course, increases your risk of failure. But you have studied your options, talked with advisors, and everyone agrees it’s a smart and potentially lucrative move.
Your bank has been there with you from your initial start-up. They know you, your integrity, and the way you run your business. So when your bank requests a personal guarantee to borrow money for your business, it can be upsetting. Why do they need a personal guarantee on this loan? Is it a reflection of the bank’s assessment of my business or my plans? Does it mean the bank doesn’t think my business is worth the risk?
The quick answer to all of those questions is no, it’s common for banks to request personal guarantees before making small business loans. It’s reassurance that you are willing to assume more risk to assure your business’ success.
It’s not personal
Personal guarantees on loans to small businesses (businesses with valuation of up to $25 million), while typically required, became the norm as states enacted legislation introducing new corporate structure options such as the limited liability company or LLC. Unlike a sole proprietorship or general partnership structure, the LLC shields owners and investors from personal financial responsibility for the business’ debt. The advent and popularity of the LLC among small business owners prompted bankers to require personal guarantees from owners.
“It’s understandable that you want to limit your liability, but we have to ensure the owner stays very involved and engaged. He or she is the key figure, and the most valuable asset of the business, and we (the bank) want to keep the owner motivated and involved,” said BBVA Compass Director of Credit Risk - Small Business David Peacock.
At most small businesses, the owner is the CEO, the face, and the visionary of the business. The owner knows the customers and vendors, the employees and community, and the opportunities and risks. If a small business defaults on a bank loan, it’s difficult to find another CEO with the needed specific skill set that the bank can hire to keep the business going, says Tommy Crawford, Director of Business Loan Underwriting.
“The CEO is absolutely the key to the success of the business, and a personal guarantee increases my confidence in the CEO and in the company,” Crawford says.
SBA loans require guarantees
Another reason to require a personal guarantee is that they are required by some government-backed loans. For all SBA loans, personal guarantees are required from every owner of 20 percent or more of the business, as well as from other individuals who hold key management positions.
BBVA Compass typically requires an unlimited personal guarantee from an owner or CEO, which provides additional protection to the bank for collecting existing and future debts, says Credit Manager David Battles.
In some cases, where ownership is dispersed among a number of different owners—such as a large law firm or medical group, for instance—the bank will consider and sometimes accept a limited guarantee shared by all business partners, says Battles. “In most cases, customers understand why the bank requires a guarantee,” says Battles. “They understand it’s simply a part of doing business.”