Why Do Lenders Require Personal Guarantees?

One of the hardest banking concepts that I have ever had to deal with was explaining why banks require personal guarantees - especially from a well managed, profitable business.

Banks look for three sources of repayment when underwriting loans. They have found over time that three sources of repayment usually mean that they do not lose as much should a borrower walk away from a loan.

The first source of repayment is typically cash flow from business operations. The business generates profits or converts current assets, which are used to pay back the loan facility.

The second source of repayment is the liquidation of collateral. Should the business default, the bank can take the collateral, liquidate it, and hopefully realize enough to cover the loan amount, lost interest, and costs associated with taking and selling the asset.

The third source of repayment is personal guarantees. The bank or lender wants you to have as much risk in the loan as they do. With a personal guarantee, banks feel that borrowers will think twice or more before just walking away. Further, should the above two sources not be enough to cover the bank's loses; the bank could come after your personal assets (checking and savings accounts, retirement accounts, and property - your house, your car, etc.) to cover its losses.

Keep this in mind: Banks and most lenders do not lend their own money. They lend the money of their depositors or investors. They have obligation to them not to lose their funds. Further, banks are in the money business. They lend money and expect to get paid back with interest and fees. Therefore, they work very hard to ensure that this happens. Probably just are hard as you do to ensure your customers will pay you for your products and services.

So, unless your business is a multinational business with huge profits and decades of operating history, be prepared to provide a personal guarantee that is just they way it is - even more today given the state of the economy.

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