This article was originally published in 2012 and was updated with new information in June, 2017.
What Is A Personal Guarantee?
A personal guarantee is an individual’s legal promise to repay the debts of a business in the event that the business defaults on the debt. The guaranteeing individual is known as the guarantor, and the entity that the business owes the money to is the creditor.
Personal guarantees are by definition unsecured, which means that they’re not tied to any one asset. Therefore, a creditor can come after any and all of the guarantor’s assets (your home, boat, stamp collection, complete set of Seinfeld DVDs…you get the idea) in order to satisfy the debt. Moreover, the creditor is generally not required to go after the business’ assets first before going after the guarantor’s assets in order to satisfy the debt.
When it comes to small business lending, personal guarantees are the norm. The SBA requires that every owner that owns a 20% or more stake in a business must personally guarantee any SBA loan.
Personal guarantees may not occur as often when it comes to one business extending credit to another, but it’s still a common practice for businesses to include personal guarantee clauses in their credit applications.
Is It Enough To Get A Personal Guarantee? Are Lien Rights Better?
Let’s get right down to it. For construction companies that extend credit to their customers, is it better to have lien rights or a personal guarantee? If you think that dealing with mechanics lien compliance is too challenging, is it sufficient to just collect personal guarantees?
In an article we wrote,”How Can I Secure Payment If There Are No Lien or Bond Rights On The Project?“, we mentioned the use of personal guarantees, though only as an alternative remedy if lien and bond rights were not available.
That’s because I firmly believe lien and bond rights offer much, much more security than a personal guaranty, because when it comes right down to it, a personal guarantee is only as good as the person signing it.
The mechanics lien or bond rights provide the absolute best security for a company extending credit to a construction project. If the account is unpaid, you open all types of options to get you paid and the underlying claim is secured by the property itself. Lien claimants can enforce their claim in court, forcing a sale of the underlying asset in order to satisfy the debt. With a personal guarantee, you are limited to just going after the guarantor’s assets, and they have the (somewhat drastic yet still viable) option of declaring personal bankruptcy to limit the guarantee’s potential recourse.
For more information on industry best practices to secure your payments through effective lien rights management, please download our free eBook: 17 Ways A Mechanics Lien Works To Get You Paid.