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Let's say an individual takes out a business loan, incorporates (or whatever), hires a team and works awhile. Eventually the venture fails. Is this individual completely on-hook for the millions he borrowed?

On the surface it seems like this is an intuitive "yes!". However, this seems to create a very high barrier for entry (high risk) for new business owners / founders. It seems that if a business idea fails, it can ruin the person. Rather than encourage innovation, this discourages it.

So I wonder how this typically pans out in real life.

Ken - Enough about Monica
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3 Answers3

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In the U.S., it is almost impossible to get a small business loan without a personal guarantee. If you aren't willing to back your own business, why should the bank or government back it? The SBA, for example, usually requires that anyone with a 20% or higher stake in the business sign a guarantee on any loans.

After the business has been in business for a while and has assets, revenue, and collateral, it is then often possible to get additional funding from various banks without having to personally guarantee because by then the business has its own collateral.

To answer your second question ("how does this pan out?"), the small businesses that fail lose money, sometimes a lot. That money comes from the people that funded the business in the first place. In the case where someone guaranteed a small business loan, they still have to pay it back. Bankruptcy happens.

Rocky
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This depends on the structure of business (Sole proprietorship vs corporation) along with whether the founder was required to 'guarantee' the loan.

A lot of small business loans or lines of credit require that someone personally guarantee the loan, meaning they're responsible for paying it if the business defaults.

If your business has sufficient financial strength and credit profile, you will get a loan without this requirement.

Though I believe a financial guarantee from the owner can provide a lower interest rate. Not entirely sure.

schizoid04
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If you either take a loan personally and give the money to your LLC, or your LLC takes out a business loan and and you guarantee for it personally, then you are on the hook personally. The LLC doesn't protect you.

Obviously the fact that an LLC is protected in case of bankruptcy means the banks are not exactly keen on giving money to LLCs. They are much more keen if the owner guarantees personally, because that means they will get their money back, or at least it is much more likely.

So practically you have the choice between no loan, or a loan personally guaranteed by the owner, unless the LLC is doing very, very well.

gnasher729
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