Getting a startup loan or line of credit can be a great way to grow your business. But these financing tools often come with requirements that can put an entrepreneur in a tight spot.
The most prominent of these requirements is the personal guarantee, which most banks insist on with startup business loans.
Keep reading to learn more about loans with personal guarantees and why startup founders should say, “No thanks!”
What is a personal guarantee?
A personal guarantee is an agreement obligating the borrower to pay back their business loan personally if the business cannot do so.
Almost all banks offering startup business loans require personal guarantees. Entrepreneurs who borrow from traditional banks frequently sign away their personal assets in loan agreements without question, unaware that a personal guarantee isn't always necessary.
As part of the personal guarantee agreement, a lender can take possession of the borrower’s personal assets if they fail to pay back their loan. For example, the lender can collect money from a personal bank account, take over other assets, or garnish wages in order to collect payment on the loan.
By signing such an agreement, you're betting the vast majority of what you own, personally, on your business’s ability to repay the loan.
The way personal guarantees on startup business loans are structured differ from loan to loan.
In some cases, the personal guarantee covers only a portion of the loan. In other cases, it applies to the entire loan, as well as any interest and fees that the borrower might owe.
Sometimes, a guarantee may be set up as a limited personal guarantee (for a portion of the loan amount) allowing it to automatically convert into an unlimited personal guarantee (for the entire loan amount) if the borrower takes certain negative actions, such as missing payments. In most cases, however, a lender will impose an unlimited guarantee.
Don't bet your life's savings on your startup's success
No one wants to think about the possibility of their startup failing, but the reality is most do. Why? Because they run out of money.
Borrowers should really think twice before signing a personal guarantee on a business loan to fund their startup. These agreements can spell major trouble for entrepreneurs since it takes little more than a shakeup in management, a downturn in the market, or new competition entering the field to end up costing you BIG.
You're risking everything you’ve ever built or done in your life on a business loan. Don't.
What's more, such arrangements are artificial structures that box in founders, which is the opposite of how we strive to engage with our borrowers at Lighter Capital. We want founders to have freedom and control — and to feel confident while working to grow their ventures without undue stress. Personal guarantees lead to the exact opposite.
We carefully select the startups we approve for funding without making founders bet their life’s savings on it.
Why do entrepreneurs agree to these loans?
If personal guarantees are so oppressive, then why do founders continue to agree to sign them?
The short answer is that it’s sometimes the only way for startup business owners to get the funding they need. Even if it’s not, they likely aren’t aware they have any alternatives.
It’s just the way business is done, and it’s something banks have done forever.
Banks require personal guarantees on loans because it forces business owners to put more “skin in the game.” A founder can’t walk away if they’re personally liable. Even if a bank knows that a founder doesn’t have a lot of personal assets, the bank might still force them to sign a personal guarantee as a motivator to ensure repayment; it’s about control and leverage.
Unfortunately for many borrowers, agreeing to that form of control is the only way of securing business funding. There are relatively few startup financing options that don’t carry this requirement, and even those of us who don't are quite selective.
Business loans without a personal guarantee
At Lighter Capital, our financial solutions are designed to be as favorable to entrepreneurs as possible. We want to see our borrowers minimize their risk and maintain their control and ownership of their company — and the rest of their assets — because we want them to be wildly successful!
That’s why our loans do not require personal guarantees.
Our stance on personal guarantees is just one of the many reasons founders tend to find our funding options more appealing than the business loans offered by traditional banks.
Check out a side-by-side comparison of our startup funding structures to get a better understanding of how we're different from a typical bank and to see why we're an ideal lending partner for tech startups.
Personal guarantees on business loans are designed to reduce a bank’s risk when lending out money to business owners who may not demonstrate traditional signals of creditworthiness. A lender who offers loans without personal guarantees must have some other way of reducing their risk.
Lighter Capital's ability to offer startup loans without personal guarantees is a function of the specific way we do business as a specialized lender. We reduce our risk thorough our data-driven vetting process for borrowers; we only lend to companies that we assess to be likely to succeed. Since we lend in a particular niche — early-stage tech companies — we have a very good sense of what it takes for these companies to make it.
Other lenders with different business models, priorities, and borrower profiles don’t have the luxury of being as choosy in their lending as we do, so personal guarantees are how they ensure they can manage potential losses and minimize their risk.
Before you sign on the dotted line, carefully weigh the potential pros and cons of taking on a personal guarantee on a business loan.
Shopping for debt?
Don't sign a loan agreement until you've read our debt buyer's guide. We give you 10 questions to ask that will help you navigate tricky terms and conditions so you and your startup can avoid unexpected costs and unnecessary risk.