Founder guarantees can create a tough decision for first-time founders and serial business owners alike. Do you give a personal guarantee to access credit for your business, or do you look into limited other ways to get the funds you need?
Let’s take a closer look at how a founder’s guarantees work, the risks involved, and when you should take a different approach entirely.
What is a founder guarantee or personal guarantee?
Simply put, personal guarantees are a legally binding promise to repay credit that your business has received.
Founders give guarantees to get loans or business credit cards for startups, existing businesses, and solopreneur ventures. Given that these founders are typically highly motivated to develop their businesses, lenders are willing to lend to borrowers who give personal guarantees.
And that’s because such guarantees give lenders the power to take personal assets if repayments stop. That’s why it’s crucial to choose the right type of guarantee for you. More about that later.
What is needed for a personal guarantee?
The short answer: a lot. For starters, you’ll need to give a complete record of all your personal assets and liabilities. Here is a closer look at what founders need to provide lenders and many corporate card issuers when giving a personal guarantee to access business credit:
- Founder and business records. You’ll need to explain who you are, your management credentials, and the business you’re in. Alongside this overview, you’ll need to give the lender your personal financial records. And every owner, partner, or stockholder owning at least 20% of the business should be prepared to do the same.
- The business’s credit needs. This is where you give a detailed estimate of how much capital will be needed to start up or expand. This includes how much you have now and how much you will need to borrow.
- Financial forecasts for the business: This can include month-by-month revenue projections, cash flow projections, and any assumptions about expenses and profit for the first two to four quarters. Here, the lender wants to assess your financial culture.
- What collateral you can provide: This could be your family home, your cars, your retirement funds. In short, any asset that you can give up in case you default. You’ll need to include the market value of these assets too.
Along with these documents, you’ll need to sign the guarantee. It’s a document—that looks a little like this unconditional guarantee form from the Small Business Administration—that sets out the terms of your guarantee.
Type of founder guarantees
There are two types of personal guarantees: limited and unlimited. And the difference between them is crucial because one kind puts you at a greater risk of losing all your personal assets if you can’t honor the repayment terms.
Limited founder guarantee
Limited guarantees let lenders collect a specific dollar amount or a certain percentage of outstanding balance from a business owner. These are common when numerous principals can pay a portion of the debt. The upside of limited guarantees is that they put a cap on how much the lender can recover from one individual. Limited guarantees may be a fit for founders who want access to more options for lenders and the possibility of lower interest rates.
Unlimited founder guarantee
Unlimited founder guarantees hold the greater risk. The guarantor is responsible for the entire loan repayment and possibly legal fees. The Small Business Administration’s loan program is an example. Many SBA loans require limitless personal guarantees from any borrower with a 20% ownership stake. Unlimited guarantees may be a fit for founders who want to borrow from the SBA’s program.
Pros and cons of personal guarantees
Cash flow and working capital are top of mind for founders in the early days of a new business. And founder guarantees are one way to get around obstacles created by ‘thin’ credit histories or subpar credit scores—both of which are significant roadblocks to securing entire swathes of business credit. There are other benefits too:
- Founder guarantees boost your application’s appeal to lenders.
- Being a guarantor may help you get favorable interest rates.
- And if you’re approved, your business has the credit it needs.
But personal guarantees are far from problem-free, for guarantors and lenders alike. When a business declares bankruptcy, lenders can continue to seek their funds from the guarantor. Here are the drawbacks:
- Losing personal assets and wealth could take a toll on your family’s future
- The long-term consequences can be severe, such as bankruptcy
- Mental health challenges due to extreme financial stress
All of which raises an obvious question. Should you sign a founder guarantee for your business?
What to consider before signing a founder guarantee
For some founders, personal guarantees are just a reality of owning a small business. For others, they stand out as too great a risk. Here are two sides of the coin.
- Founders should sign personal guarantees when they are assured of backup funds to pay off the debt or a clear path to business growth and revenue stability.
- Founders should avoid personal guarantees if their business is already struggling and they have no viable means of repayment if things go wrong.
Businesses can be faced with uncertainty at any moment. Often such challenges—like economic downturns or natural disasters—are no fault of these founders. Yet, that doesn’t change the reality that the founder’s guarantee would still stand, even during black swan events.
Tips and best practices for guarantors
The headline here is to tread carefully. No one enjoys reading the fine print, but when it comes to founder guarantees, you need to go through the guarantor application requirements and the lender documentation with a fine-tooth comb. Specifically, you should:
- Understand business spend: Ensure you are confident in the business’s long-term viability, especially if you’re a co-owner considering offering a personal guarantee. This entails becoming active in all aspects of the business to guarantee that no financial problems lurk around the corner.
- Understand your exposure: Check what the lender or card issuer will demand if you default. As mentioned earlier, you’ll likely be up not only for the principal and interest of the original loan but the lender’s legal and administrative costs too.
- Get a legal opinion: Again, this is about attention to detail. Yes, it would be best if you pored over the guarantee agreement. But you should not be the only one to do that. It’s not a time to go it alone. Ask your lawyer and accountant to review the papers, and if you don’t have these professionals at the ready, take the time to go seek them out.
- Pause before signing: Vouch only for a business that you wholly or primarily own. If your ownership stake is small, or your co-founder relationship is fraught, then it pays to stop and think before putting pen to paper. Personal guarantees can still be enforceable even after you’ve sold out of the business—which means someone else’s bad financial management or just plain old-fashioned misfortune can put your personal assets at risk in the future.
Is a founder guarantee good for me?
Becoming a guarantor for your business is a challenging reality of being a founder. All of the risks rest on you, and in an already high-pressure business environment, that can be an added strain that you don’t need. But it can get you the credit you want to give your business the funds it needs for essential projects and recurring expenses. The choice is yours.
Get a corporate card without being a guarantor
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Founder guarantees are part of our Ramp Finance Glossary.