Navigating the world of finance can often feel like wondering in a maze, especially when it comes to understanding concepts like personal guarantees.
So, what is a personal guarantee exactly?
Simply put, a personal guarantee is a promise made by an individual—often a business owner—to shoulder the debt of another if they fail to fulfill their payment obligations.
This commitment can bring with it potential benefits, but also substantial risks, as it ties your personal assets and credit to the success or failure of the debt repayment.
In this article, we’ll unpack the ins and outs of personal guarantees, exploring when they’re required, the benefits they offer, the risks they pose, and how you can navigate them to your advantage. Whether you’re a shareholder, director, or business owner, this guide will provide you with the essential knowledge you need to understand personal guarantees and how they could impact your financial journey.
What is a Personal Guarantee?
A personal guarantee is when an individual guarantees to pay the debt of another should they default or not pay the debt.
The individual will use their own personal credit and may use their own personal assets as collateral for the debt in the application. They will have to use their own capital (income and/ or assets) to fulfill the debt in the event that the other party fails to honour or pay.
A personal guarantee for business debt is usually made by Shareholder/s, Director/s, Owner/s as they are personally backing the business should they default or be unable to fulfill the debt obligation. Business owners should read the terms and conditions of any credit application carefully as the language that highlights personal liability may not be clear or properly understood if you are not familiar with personal guarantees.
A personal guarantee is like being a “co-borrower”, however, when it is required; the benefits/ risks; and how it works with debts is sometimes unclear.
When is a Personal Guarantee Required?
Personal guarantees provide an extra level of protection to the lender who issues the debt as they want to make sure that the loan will get repaid. Personal guarantees can also, help newer or unestablished businesses to get credit or when the business does not have adequate credit history or assets to qualify on their own.
Benefits of Personal Guarantees
A personal guarantee could improve the conditions of the business’ debt. It may receive a lower interest rate, a larger loan amount to borrow, or a longer payoff term. In fact, some individuals use a personal guarantee even when it’s not required just so they can take advantage of these benefits as, the better the personal credit, the better the borrowing terms the business can expect.
Risks of Personal Guarantees
When a personal guarantee is given, the individual of the business may pledge their own asset/s as collateral and/or agree to repay a debt from their own personal capital should the company default or be unable to pay. When pledging an asset/s as collateral, this allows for the asset to be seized in the event of default or non-payment, this could be an investment, vehicle or even a principal residence. Therefore, the personal risk high. Additionally, this ties the asset to the debt and could be difficult or challenging to sell or transfer before the debt is paid in full.
Additionally, even if the company ceases operation or even closes, this liability is still fully realizable against the person who guaranteed it.
Personal guarantees are “jointly and severally” tied to the business. This means that both/ all parties are responsible to the entire debt plus interest and other fees if applicable until the debt is paid in full.
How Can Frederick and Company Help You
When facing financial difficulties either as an individual, business or both, you can set up a free one on one consultation where we will meet with you and review your entire circumstance to determine your risks and financial options to enable you to determine which plan is best for you and/ or your business, if applicable.
If you are self-employed, a shareholder, director, or owner of a business or tied to a business, we can help review all contracts to determine if a personal guarantee is in place.
Please give us a call at 587-269-3009 for a free initial consultation in Alberta. Visit our website for more information or get in touch with us to book a free consultation – we’d be more than happy to assist.