Read this before you personally guarantee a business loan

When your business needs to take out a loan, you, as the owner, may be asked to provide a personal guaranty (aka guarantee). This guaranty makes you, as the guarantor, personally responsible for the business debt if it goes into default. The guaranty required can be either limited—which means that it applies to the single loan in question—or unlimited—which means that it applies to all existing and future loans between your company and the lender.

Requiring this type of guaranty effectively helps your lender get around the limited liability your LLC or corporation provides. By requiring your personal guaranty, the lender is circumventing the carefully designed liability protection you built into your business formation and the lender is able to access your personal assets if your business defaults on the loan.

Before you provide such a guaranty, it's important to understand the commitment you're making.

Continuing guaranties

A continuing or unconditional guaranty (also called an unlimited guaranty or general continuing guaranty) is a wide-reaching personal guaranty for a business debt. This kind of guaranty will make you personally responsible for all of your business's past, present, and future loans with the lender, even though you're basically signing it to get just one loan at the time. It's designed to protect the lender, by keeping you personally on the hook for every obligation your business already has or creates in the future with that institution.

If you sign an unlimited or continuing guaranty, one benefit is that the lender can lend you additional funds as you need them and your original guaranty will stretch to cover them, so you won't need to complete a guaranty each time. It's important to understand the implications of the unlimited guaranty though, because all of your personal assets can be accessed by the lender if your business defaults on the loan.

For example, if Dustpans LLC borrows money from ABC Bank so that it can build a warehouse, ABC could require the company's owner, John Doe, to provide a continuing guaranty. This means that John personally will be responsible for the full amount of the loan (including fees, costs, and interest), and it also means he'll be on the hook for any and all other loans Dustpans LLC has or takes out in the future from ABC Bank. This can add up to a lot of personal liability, particularly since he formed the LLC specifically to protect himself from such liability.

Limited guaranties

A limited guaranty is a guaranty for one particular loan only. You, as the guarantor, are personally liable for the amount of that loan only, not for any others your business may have with that lender. If your business wants to borrow additional funds, then you'll likely have to create a new guaranty for each additional disbursement. The limited guaranty will only cover the loan it is tied to and will generally only stay in effect for the life of that loan.

If Dustpans LLC takes out a loan from ABC Bank and ABC requires a limited guaranty from John Doe, then John is on the hook only for that loan and that loan alone with ABC Bank. If Dustpans LLC takes out another loan next year with ABC, John Doe has no personal responsibility for that loan, unless he signs a separate guaranty.

Termination of guaranties

So in this scenario, a limited guaranty ends when the loan is paid in full. It does not continue past the life of that loan. A continuing or unlimited guaranty, however, continues until and unless it is terminated by the guarantor (the person making the guaranty). Most agreements with lenders will require you to waive your right to terminate the guaranty so that there is no way for you to avoid being personally liable if a default happens.

Creating a guaranty

A continuing guaranty on a loan needs to be in writing, and it's a good idea to get legal assistance in creating either a limited guaranty or an unlimited guaranty. Using a limited guaranty form or an unlimited continuing guaranty form can help ensure you are relying on tested and reliable language for the guaranty.

Generally, your lender will provide you with the form they require, and you should be sure to have it reviewed by an attorney or legal service. Each state has its own requirements for execution, and whether notarization is required, so it's important to check your state laws.

When taking out a business loan, it's essential that you understand the difference between a limited and unlimited guaranty. The nature of your personal liability to the lender is very different in each situation, yet both types of guaranties may be worth considering as you grow your business.