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When considering financing options for your business, the question often arises: “Do I need to sign a personal guarantee for an SBA loan?” This query is especially prevalent for those looking into SBA 7A or SBA 504 loans. The answer is straightforward: yes, if you own more than 20% of the business, you will need to provide a personal guarantee. This blog post delves into the details and reasons behind this requirement, helping you understand what to expect when pursuing SBA financing.
What is a Personal Guarantee?
A personal guarantee is a commitment by the business owner(s) to repay the loan personally if the business cannot. This means that your personal assets, such as your home, car, and bank accounts, are on the line. This guarantee is a way for lenders to mitigate risk, ensuring that there is a high level of confidence in the borrower’s commitment to the business's success.
Why SBA Loans Require Personal Guarantees
The Nature of SBA Loans
SBA loans, particularly the 7A and 504 programs, are designed to support small businesses by providing access to substantial financing. These loans can finance up to 90% of the total project cost, offering leverage that is hard to find with other financing options. Given the high leverage and the associated risk, it is understandable why the SBA requires a personal guarantee from owners with significant stakes in the business.
Comparison with Other Loans
Most business credit cards, home loans, and auto loans also require personal guarantees. This requirement is not unique to SBA loans but is a standard practice in the lending industry. Even larger commercial deals, such as those involving agency debt like Fannie Mae or Freddie Mac, sometimes avoid personal guarantees. However, these are typically non-recourse loans, which means the lender cannot pursue personal assets if the loan defaults.
Who Needs to Sign a Personal Guarantee?
Owners with More Than 20% Interest
If you own more than 20% of the business entity, you will need to sign a personal guarantee for an SBA loan. This rule is part of the SBA's standard operating procedure (SOP) and is non-negotiable. The rationale is that significant stakeholders should have a vested interest in the success of the business, backed by a personal financial commitment.
Investors with Less Than 20% Interest
For investors who own less than 20% of the business, signing a personal guarantee is typically not required. However, it's essential to note that banks might sometimes overlay this rule and ask for guarantees from these smaller stakeholders as well. While this is not common practice, it’s a possibility to be aware of.
The Benefits and Risks of Signing a Personal Guarantee
Access to High Leverage Financing
One of the primary benefits of signing a personal guarantee for an SBA loan is access to high leverage financing. With the ability to finance up to 90% of the total project cost, SBA loans provide opportunities that are otherwise challenging to secure. This level of financing can be instrumental in the growth and success of your business.
Demonstrating Confidence in Your Business
Agreeing to a personal guarantee signals confidence in your business venture. It shows lenders that you are fully committed to the success of your business and are willing to take personal financial responsibility to ensure its success.
Potential Risks
The most significant risk of a personal guarantee is the potential loss of personal assets. If your business fails and cannot repay the loan, your personal finances are at stake. This risk underscores the importance of thoroughly evaluating your business plan and ensuring you have a high level of confidence in its success before committing to a personal guarantee.
Conclusion
In summary, if you are pursuing an SBA 7A or SBA 504 loan and own more than 20% of your business, you will need to sign a personal guarantee. This requirement aligns with standard lending practices and ensures that significant stakeholders are fully committed to the business's success. While this guarantee carries personal financial risks, it also opens the door to substantial financing opportunities, providing a crucial advantage for your business growth. Understanding these dynamics will help you make informed decisions as you navigate the path to securing SBA financing.