What you need to know about personal guarantees & how to remove them
Starting with the basics: a personal guarantee is a commitment from an individual, often the business owner, to guarantee payment on a business loan if the corporate borrower fails to pay. If the lender calls the entire loan and the company fails to pay, then the individual will be obligated to pay the entire loan amount.
Conversely, a limited personal guarantee has a specific dollar amount ceiling in which the individual would owe the bank. They are often used in cases where multiple individuals guarantee a business loan. This prevents any one guarantor from being obligated to pay the entire loan amount.
When is a personal guarantee required?
Lenders require personal guarantees when a corporate borrower is not strong enough to stand on its own. The credit strength of a company is based on the lender’s proprietary risk rating system. Lenders are looking at a number of primary variables such as cash flows, assets, growth, and industry to make a determination of the company’s strength.
A secondary source of repayment is often collateral. Collateral could be the receivables, inventory, or real estate owned by the company. A lender is most likely to move forward with issuing a loan if both the primary and secondary sources of repayment are strong. Personal guarantees are often required if the secondary source of repayment is insufficient to cover the loan amount.
The only instance when a personal guarantee would not be required is if the company’s secondary source of income is valued at more than the total loan obligation. Keep in mind the bank will discount each asset class based on their view of its risk. For example, cash will have an advance rate of +95% while inventory may be valued at 30% of its book value, and other asset classes could fall somewhere in between.
How do I remove a personal guarantee?
Simply ask your lender. This may seem a bit counterintuitive since it was your lender that required it in the first place; however, there are two reasons why a lender would consider removing a personal guarantee.
1. Operational performance
If the company’s operations have shown material improvement with stronger than expected cash flows, increased value of balance sheet assets, or more diversified customer base, then the lender may be able to remove the personal guarantee on the existing loan. The company would need to contact their bank and provide updated financial statements to explain the strong performance.
2. External market shifts
The corporate borrowing market is constantly shifting. Commercial lenders could consider relaxing their requirements in the face of pressures from new players who undercut on terms and pricing to win market share, as well as slow loan growth and relaxed regulations.
However, a company must place competitive pressure on their lender in order for them to preemptively remove the guarantee prior to refinancing. Knowledge of these market shifts is essential for CFOs to advocate for better terms for their commercial loans. In this case, the company would need to imply that the lender could lose their business if they don’t match terms other lenders are providing.
The advantage to having your current lender remove personal guarantees is you might not have to refinance because they have the power to change the terms before the loan matures. If this is the case, the company saves on closing costs, due diligence, and time.
My lender won’t remove the personal guarantee. What are my other options?
Lenders require personal guarantees because they feel that the corporate borrower doesn’t have the credit strength sufficient to carry the debt. Evaluation of credit strength is based on each lender’s own proprietary methodology for determining credit strength. Therefore, just because one or two lenders require a personal guarantee doesn’t mean all lenders will require it.
Consider engaging non-bank and other niche lenders to expand your financing options. Including a diverse set of lenders governed by different types of regulators will not only result in more competitive pricing options but will also return more options for the terms of the loan.
While engaging in a full RFP process might seem too time consuming to do before the loan matures, Cerebro Capital offers a streamlined online RFP system that will help your company get the best deal, which means the best rates with terms that the owners will approve. Companies can usually expect term sheets from lenders who match their needs within 21 days. Success-fee only pricing means companies have little to lose when trying to find a new lender.
Furthermore, we have a proprietary system that scans a national network of lenders over time and alerts clients the moment any lender can remove a personal guarantee from a specific loan. This helps companies put competitive pressure on their existing lenders or it gives them a clear view of term options prior to starting an RFP process.
Contact us today for more information on or to explore this platform.