For small business owners looking to expand their enterprise, getting a business loan may be a crucial first step. However, getting a business loan without a personal guarantee can be hard, especially for startups lacking strong business credit.
By strategically planning from the beginning, you can quickly build solid business credit that can help make it possible to eliminate the need to sign a personal guarantee to get business loans.
The key is understanding both how business loans work and the challenging process of getting business loans separate from your personal credit. This starts with creating a separate business entity that doesn’t rely on your personal assets to get credit.
Building your business credit is contingent on your company's performance, credit and payment history, not your own. By building your business credit history, it won't long before you’re getting unsecured business loans in your business' name.
To achieve this, it’s important to understand the fundamentals of the process.
What Is an Unsecured Business Loan?
An unsecured business loan is financing that doesn't require collateral for approval, such as real estate, business property, or vehicles. These loans differ from secured loans, which are backed by collateral and may lead to the loss of that collateral if a borrower defaults on the loan.
Lenders grant unsecured business loans based on creditworthiness and financial history, rather than assets. These business loans often have higher interest rates because these loans represent increased risk to the lender of nonpayment. But these higher-cost business loans can be a viable option for business owners who lack collateral or don’t want to risk valuable assets.
However, it's important to understand that while unsecured business loans don't require collateral, lenders may require you to sign a personal guarantee for them. That makes you personally responsible for repaying the loan if your business doesn’t.
It's crucial to thoroughly evaluate your business's financial position and growth potential before borrowing. Make sure you have a solid understanding of the unsecured loan’s terms and conditions before you sign any documents.
By strategically planning from the beginning, you can quickly build solid business credit that will make it possible to eliminate the need to sign a personal guarantee to get business loans.
What Is a Personal Guarantee for a Business Loan?
A personal guarantee is a written commitment a business owner makes to repay a business loan from personal assets if their business can’t repay. It makes the business owner a personal co-signer on the business loan, using those assets as collateral on the business loan. Many lenders require a personal guarantee as security on business loans.
That’s because there’s an inherent risk to lenders related to small business lending. Small businesses, particularly startups, often lack the established credit history and assets that lenders use to determine their ability to repay debt. A personal guarantee helps mitigate this risk by providing an additional layer of protection for the lender.
For instance, if you apply for a business loan to purchase new equipment or expand operations, the lender may require your personal guarantee as part of the loan agreement. Then, if your business doesn’t repay the loan and you can't cover the debt, the lender can take legal action to seize your personal assets to repay the business loan. That could include your home, car, or savings.
Making a personal guarantee on the business loan is a significant commitment. You should understand and consider the implications fully before personally guaranteeing any business loan agreement.
How To Get a Business Loan with No Personal Guarantee
Getting a business loan with no personal guarantee might prove challenging, but it's not impossible. There are strategies you can use to circumvent a personal guarantee requirement.
Here are several ways you can avoid providing personal guarantees when applying for business loans and rely on your business as a loan guarantor:
1. Must be either incorporated or a limited liability company
Your business must be incorporated or registered as a limited liability company (LLC) to build business credit. Otherwise, your personal credit will remain linked to your business loan interest rate. No matter how long you’ve been in business, if your business isn’t a corporation or an LLC, then banks and financial institutions consider any loans personal debt. That can mean a much higher interest rate on the debt—up to 8 to 10 percent higher for a personal loan.
Consider preparing a solid business plan that overviews your vision and outlines your business strategies, operational plans, and revenue projections. Make sure the entity has corporate or company books, financial and other documents in its own name. Lenders may want to see all these to establish the stability of your business and its ability to repay debt before approving your loan application.
As importantly, consider getting help to incorporate or organize your business as an LLC and to create its books before seeking business loans.
2. Build up your history with successful payments
The most common business credit rating service is Dun & Bradstreet, commonly referred to as D&B. There are others, but this is the one most banks use to establish your company's creditworthiness. It's also the one your suppliers will use to set your company's credit terms for purchases.
A D&B business credit report contains your company's history of payments to all your business creditors. These could include payments to the banks, suppliers, and vendors you’ve gotten business credit from, and even smaller bills your business pays every day.
The report includes a score that is tied to your company's ability to pay its invoices. Depending on how fast you pay those invoices, your D&B report will provide a high, good rating, or a low, bad rating. This grade or scale is your "paydex" score and is the ultimate indicator of your company's ability to pay its bills.
Banks and other businesses use this rating to determine your interest rates on loans, the amount of credit, and the terms they grant your business. Your company may also use the D&B report of its customers to grant or refuse them credit with your business.
3. The "paydex" score is based on a weighted average
Perhaps the most important aspect of your paydex score is understanding that it is a weighted average score. That means the highest dollar value invoices, bills, or payments your company makes carries the most weight in your paydex score.
So, when paying your invoices, pay those with the highest value first. This will ensure your paydex score is within an acceptable range. It's also imperative that you take an active role in managing your paydex score.
Take the time to speak with your creditors and work with them to make sure they know when you’ll pay them. Having a high paydex score will get your business lower interest rate loans, more favorable terms with customers, and save your business money.
4. Build credit with suppliers that do not require a paydex score or personal guarantee
Many business suppliers, particularly office and industrial supply companies, do not require a paydex score or personal guarantee to establish credit accounts with them. They might require prepayment on initial orders, and they may start you off with a fairly low limit. However, you can build higher credit limits and longer terms with them.
If you want to establish business credit, consider using these suppliers rather than shopping at the local office supply or warehouse store with a company check or personal credit card. Some recognized suppliers that can help you establish your business credit include:
- Uline — shipping supplies
- Grainger — office and industrial supplies
- Quill — office supplies
- S. Walter Packaging — retail packaging
- Global Industrial — industrial supplies, fixtures and furniture
Make sure you confirm their current business credit policies still allow you to establish business trade lines with them without personal guarantees or paydex scores.
5. Shop around and negotiate with lenders
If one lender insists on a personal guarantee, there are many other lenders you can consider. Consider giving yourself a range of options by researching them carefully and applying to select bank and non-bank lenders. Also, it's worth negotiating with lenders. Carefully discussing the terms and conditions of business credit offerings with them might improve lending terms.
The Takeaway
Getting business loans with no personal guarantee is difficult, but by taking the right steps to set your business up properly from the outset, it’s possible. Start by making sure your business is formed as a separate entity from you and its credit is tied to its performance, not your credit. Understand the key differences between business and personal credit and use your business to get and build business credit to ensure you will not be personally liable for any of your business debt.
Ensuring this will provide your business with better interest rates on business loans, and better credit lines and terms with your suppliers. Use the steps and resources here to set your business up for business lending success.
A version of this article was originally published on October 7, 2010.
Photo: Getty Images
