What’s the Difference Between Business Collateral and a Personal Guarantee?
Collateral, in general, is a guarantee to a lender that if a borrower cannot pay their debts, the lender can appropriate pledged assets. Collateral tends to be physical items or assets. For example: a home, cash, property, etc. Collateral is a huge part of the lending process because it protects the lender. Without collateral, a lender would never really be able to insure that they would get any amount of their money back. Because of this, the higher the worth of the collateral, the bigger the loan can be because the lender knows that they will be able to be paid back one way or another in an amount that is equivalent to the amount loaned.
Business collateral follows the same guidelines of ordinary collateral—it is a guarantee to the lender that the borrower will either pay them back or surrender their collateral. With business collateral, the assets that make up the collateral are usually business assets like buildings, percentages of income, ownership of the business, equipment, cash deposits, etc. The collateral used in business collateral for loans is not usually personal items from the business owner—they are assets tied up within the company itself.
With business collateral, the owner (or owners) of the business is responsible for managing the loan and making payments. They are also responsible for the surrendering of business assets to the lender if the loan defaults. Often times, owners will also have a personal guarantee on the loan as well as business collateral to help in the case of a defaulted loan.
A personal guarantee also follows the principles of collateral; however, a personal guarantee allows for a lender to seize personal assets as well as business assets if the business goes under. A personal guarantee is like a double layer of protection for a lender. If the first layer—business collateral—fails to pay back a defaulted loan, a personal guarantee is there to pay it back. The kind of assets that personal guarantees operate on are things like investments, a house, personal property, etc.
A business owner does not have to be the one who makes the personal guarantee on a loan. Personal guarantees can also come from people outside of the company that is borrowing money. In that case, it is like this individual or company is co-signing a lease. They agree to pay back any debts that are owed if the original person or business taking out the loan cannot afford to pay them back.
For more business loans questions, check out our Business Loans FAQ Page!