We all want to make it on our own, but sometimes you need help. That’s doubly true when you’re applying for a small business loan that requires a co-signer. It may be necessary, but before you search for someone to sign that dotted line, read on for pros and cons about co-signed business funding.
A co-signed small business loan is any form of business funding that is guaranteed by a co-signer. A co-signer, or “guarantor,” agrees to pay if you default on the loan. Typically, a co-signer has good to excellent credit and substantial assets.
Having a co-signer on your loan doesn’t add much risk to your business, but it could seriously jeopardize your relationship with the co-signer, which may lead to added stress for you.
There is another way to look at needing a co-signer: If you weren’t able to qualify for the loan on your own, maybe that says something about your ability to repay the loan.
It should also be noted that you may need to sign a personal guarantee. A personal guarantee is an agreement you make with the lender where if you cannot pay back the loan with your business’s profits, then you will personally pay back the loan. If that falls through, then it’ll be up to your co-signer to repay the loan.
Warning: If you sign a personal guarantee, then even if you own a limited liability company (LLC) or an S corporation, your personal assets may still be jeopardy if you default on the loan. The same goes for your co-signer. For these reasons (and many more), you should have a professional look over your loan agreement before you sign anything.
Your co-signer should think long and hard about whether or not they want to do this for you. Here are some of the not-so-great aspects of their side of the situation:
If you decide to seek out a co-signer, make sure they know about these risks, too. You don’t want them to say later on that you tricked them into anything.
Let’s assume you’re applying for a traditional business loan with an interest rate. You want that interest to be as low as possible because a lower rate usually translates to a cheaper loan. There’s a chance your credit rating alone won’t qualify you for the lowest rate. But, if you have a co-signer with an incredible credit rating, then you might be eligible for a better rate, which could end up saving you money on the loan. In some cases, lenders might be willing to offer you a higher loan amount if you have a co-signer.
That’s assuming that you’ll even qualify for the loan without a co-signer. Some lenders want you to either offer up significant collateral or have a co-signer. Collateral might not be an option for you. (We recommend that you try to avoid putting your possessions up as collateral for a business loan. If your business goes south, you don’t want to lose your assets on top of it.)
It’s up to you to decide, but whatever choice you go with, we advise you to do some serious planning. If for no other reason (and there are plenty of other good reasons), having a solid business plan will help instill confidence in your co-signer. If you can’t convince them that the loan is a good idea, then maybe it’s not.
Your lender may require your spouse to co-sign on your loan, which will make any assets your spouse owns subject to seizure if you should default on the loan. If your lender doesn’t ask your spouse to sign anything, we wouldn’t suggest bringing it up.
When the “weighted average method” is used to evaluate your co-signer, the lender will take into account how much of the business the co-signer owns. If your co-signer owns a small percentage of your company, then even if their credit score is very high, it will not have much bearing on the final decision. Conversely, the “non-weighted average method” looks the average of you and your co-signer's credit scores, regardless of how much of the business they own.
Chances are your lender will use one of those two methods to determine how much weight to give your co-signers credit score when deciding to offer you a loan, how much the loan will be, and what your interest rate will be. If your lender employs the “weighted average method,” then we suggest not bothering with a co-signer, since their impact will likely be outweighed by the risks we discussed earlier.
There are small business funding products out there that don’t require collateral or a co-signer. These products tend to have higher fees. So if you’re looking for the cheapest loan possible, you may need to go with a co-signer. And remember, just because you need one this time around doesn’t mean that’ll be the case the next time. If you pay off your debt right, then you might improve your credit enough to fly solo for next big loan.
We hope this advice helps you decide whether or not to get a co-signer on your small business loan.