When Business Loans Get Personal: Take 20 Minutes to Assess the Risks of a Personal Guarantee on a Business Loan

Key takeaways:

• Low LTV Business loans are attractive because they only require a small down payment, but the personal guarantee required by lenders can expose your personal assets to risk in the event of default.
• A personal guarantee can circumvent the protection offered by an LLC, leaving your home, your savings, and your other property vulnerable.
• The perceived security of a low LTV ratio by having “less investment to lose” is misleading, as the personal guarantee increases your financial exposure well beyond the collateral you expressly provided.
• Business owners should fully understand the risks of personal guarantees and consider negotiating terms, seeking alternative financing, and consulting with advisors to protect their personal assets.

Small Business Loans Do a Lot of Good for New Entrepreneurs and Business Owners

I am a fan of business bankers and the Small Business Administration (SBA). I am among the millions of business owners who got their start, funded their growth, or financed their exit using an SBA-backed product. The SBA does not typically lend money directly but instead guarantees a portion of loans made by approved lenders, reducing the risk for lenders and making it easier for small businesses to obtain financing. One of the most appealing aspects of SBA loans is the potential for an extremely low loan-to-value (LTV) ratio, sometimes as low as 10%.

For example, if you were buying a business valued at $500,000 with an SBA-backed loan at a 10% LTV ratio, you would only need to provide $50,000 as a down payment, while the remaining $450,000 would be financed through the loan. This allows you to acquire the business with a relatively small initial cash outlay, keeping more of your funds available for operations or growth.

For comparison, that same bank might require a 20% to 40% down payment for a conventional business loan, which means your same $50,000 investment would only finance a loan worth $125,000 to $250,000.

An SBA loan’s lower LTV ratio reduces the immediate financial burden and allows businesses to leverage their available assets more effectively. This added leverage leaves you with substantial capital to invest in your business and, absent any other considerations, can boost your cash flow and returns.

A Generously Low Down Payment Comes with a Tradeoff — the personal guarantee

I work with entrepreneurs every day and there is an obvious appeal to SBA lending. However, what many entrepreneurs may not fully realize is the hidden danger that comes with this seemingly favorable arrangement: the personal guarantee. A personal guarantee is a legal commitment by an individual to repay a loan or debt if the primary borrower defaults. Here, the primary borrower is the business and the legal commitment is provided by the entrepreneur in the event the business cannot pay its debts.

SBA loans are not unique in requiring personal guarantees—credit cards, home mortgages, and most conventional bank loans do as well. The key difference lies in the role of "goodwill" in SBA deals. In business acquisitions, goodwill represents intangible assets like brand reputation, customer relationships, intellectual property, and a skilled workforce. While goodwill can elevate a business from break-even to profitable to wildly successful, it typically lacks liquidation value. If the business fails, you must cover the gap between its sale price and what you owe. Unlike tangible assets such as inventory, which can be sold at a discount to repay part of the loan, goodwill is much harder to recover. Additionally, in my experience, SBA loans are typically much larger than any personal loans or conventional business loans available to individuals—most people cannot secure a $500,000 credit line, but SBA loans can reach up to $5,000,000. In the event of default, the personal guarantee involves significantly higher stakes than most other debts.

My Experience with an SBA Loan and a Collapsed Business During the COVID Pandemic

I took out an SBA loan to acquire a business for exactly $1,000,000. After fees and my $100,000 deposit, the remaining debt was approximately $920,000. The actual assets of the business were modest, but its real value lay in its name, location, and industry relationships that generated significant cash flow on those modest assets. This was a huge advantage while the business was profitable. However, when the COVID pandemic hit and my largest customer bought a competitor—cutting off a $1,000,000 account—the situation changed. I still owed $900,000+ to the bank, yet the full liquidation value of all assets was estimated to be under $100,000 and eventually sold for much, much less. That goodwill the bank had lent $1,000,000 for was now worthless and I would be responsible for the balance. ??

We did everything we could to keep the business going, including finding another $700,000 in new business in less than 9 months and directly those cashflows to debt payments, but it was not enough. We strategically wound down and liquidating everything we could from the business to pay down the loan. After all efforts, I was left responsible for a debt of $782,118.61, with interest accruing daily.

I had felt like a genius for getting hundreds of thousands in profits for just over $100,000 down, but those returns looked a lot less compelling when I account for the value of my other belongs and the bet I had made that I would not be responsible for the balance of my SBA loan.

Simply incorporating your business does not protect you from the personal guarantee you signed

While the LLC structure is supposed to protect your personal assets from business liabilities, the personal guarantee effectively circumvents this protection. By signing a personal guarantee, you are agreeing to cover the loan with your personal assets—such as your home, savings, and other valuable property—if the business defaults on the loan.

This scenario is particularly concerning for business owners who may not have anticipated the full extent of their liability. The very protections that an LLC is supposed to offer—shielding your personal assets from business risks—are rendered ineffective by the personal guarantee insofar as the bank can come right to you with the balance of your loan.

When you bring the personal guarantee into consideration, the calculus on your new business changes. This is no longer “bet 10% down then business will succeed,” but more like putting everything you own into play in the event you cannot satisfy the business loan using business cash flows and assets.

?? I wish every entrepreneur would take 20 minutes to read through the personal guarantee for and re-calculate what their life looks like with those loans

This message is not anti-business loan. There is a temptation to read what I am writing and decide to just never borrow money again and bootstrap everything. Entrepreneurship-by-acquisition is a real strategy that has worked for millions of aspiring business owners.

That said, given the risks associated with personal guarantees, business owners need to approach these agreements with caution. The clients I meet spent months or even years planning an acquisition. As they are now facing issues with a personal guarantee, they wish they had taken 20 minutes to consider the downside. In particular, I would want any entrepreneur to have thought about the following before committing to a personal guarantee:

1. Understand the Full Scope of the Guarantee: Before signing any loan documents, make sure you fully understand the terms of the personal guarantee. Know exactly what assets are at risk and consider how a default could impact your personal financial situation.
2. Consult with Legal and Financial Advisors: It’s crucial to seek advice from professionals who can help you navigate the complexities of SBA loans and personal guarantees. They can provide insights into how to structure your financing in a way that minimizes or at least mitigates personal risk.
3. Negotiate Terms if Possible: This might be difficult because many banks steer all entrepreneurs toward their SBA department and SBA loans do not offer much for wiggle room. Many banks will only do SBA business loans, so you need to figure out if negotiation is even an option. While it may be challenging, try to negotiate the loan package’s economics and terms, including the personal guarantee.
4. Consider Alternative Financing Options: If the risks associated with a personal guarantee are too high, explore other financing options that do not require such a guarantee. While these options might come with less leverage, slightly higher interest rates, or stricter terms, they could offer better protection for your personal assets. I have added more notes on alternative financing below.
5. Plan for Financial Contingencies and Your Overall Financial Wellbeing: Successful entrepreneurs often become masters of risk mitigation. Before you acquire your business, develop a robust financial strategy that includes contingency planning and maps out what your financial life looks like outside of your business. By preparing for potential downturns and maintaining a healthy reserve, you can reduce the likelihood of default or at least mitigate its effect on your personal assets.

What do I mean by “Alternative Financing Options?”

There is an honest, skeptical response to hearing “you should explore other financing options,” when SBA lending products seem to be the only business loans offered in town. Especially when you are an asset light business, many regional or national banks will require the loan go through their SBA department. Many small banks will not even touch an unconventional deal.

I understand and respect the frustration. In recent years, I have tried and coached others to try different tactics to help finance opportunities outside of the SBA:

1. Bid out bankers just like any other vendor. Many businesses have experience putting out bids for all sorts of projects or inputs. If financing is one of your major inputs, why not shop for that as well? This can be logistically difficult, but particularly on the conventional loan side I have found value in putting together a bid packet and shopping it around to 3-4 banks for quotes on what they would do with that loan.
2. Seller Financing. We cannot ignore a key player in any M&A deal: the seller. Most sellers understandably want all cash at closing for their business. That said, many are willing to carry some of the sale price if it means getting the deal done. The bank might even require some seller financing to keep the seller in the game post-acquisition and mitigate the risk that the goodwill of the business leaves with its original owner. I have seen deals where the seller carried 30% to 50% of the sale price, although in each case the buyer had been the only serious bidder.
3. Vendor Financing and Customer Funding. Vendor financing and customer funding are effective tools for managing post-acquisition finances and cash flow. With vendor financing (trade credit), you aim to negotiate extended terms with key suppliers. This is easier said than done, but this financing is often interest free and immediately benefits your cash cycle. Customer funding, through prepayments, co-development, or long-term contracts, allows customers to support your growth directly. I see this approach as a valuable, underutilized alternative to traditional financing. Improving cash flow post-acquisition by speeding up payments and controlling outflows is a practical strategy for reducing debt and securing the breathing room you need to service your business loans.

Please take 20 minutes to consider what a personal guarantee could mean for your personal finances. We are here if you want to talk.

While SBA loans with low LTV ratios can be a powerful tool for business growth, the requirement for a personal guarantee introduces significant risks that cannot be ignored. The very protection that an LLC is supposed to provide is compromised when you sign a personal guarantee, potentially putting all of your personal assets at risk.

Business owners must approach these loans with a clear understanding of the implications. The allure of a low LTV ratio should not overshadow the reality that a personal guarantee could jeopardize your financial future. By fully understanding the risks and taking steps to mitigate them, you can make more informed decisions about how to finance your business without putting all your personal assets on the line.