Finance · 18 December 2015

What kind of guarantees do small business funders want?

Guarantees are crucial in the funding space
Guarantees are crucial in the funding space

If someone is going to invest in your business or offer you funding in another way, they will want some form of protection for doing so, and this could take the form of guarantees or security.

KPMG’s Bivek Sharma advised that various attributes will be considered when it comes to deciding what guarantee a business needs to provide – “your trading history, the risk associated with your business, who is in your team” will all be taken into account.

“You could potentially secure loans against the value of an asset, but many small firms don’t have assets, and something we’re increasingly seeing is owners of early-stage firms asked to give personal guarantees. This is a promise made by an individual or organisation, who becomes known as the guarantor and they then accept responsibility for another party’s debt if they fail to pay it,” Sharma explained.

“If something goes wrong, they’re agreeing to pay out of their own funds. You’ll see a lot of business owners putting their house or car on the line and it’s a very high-risk thing to do.”

As alternative lenders look to challenge the established names and provide for small businesses, some have also considered the difficulties of the older systems and what hasn’t been working for entrepreneurs seeking funding.

One of the UK’s new challenger banks, OakNorth, has made it a point to distinguish itself by providing loans and short-term working capital loans that don’t always have to be secured against customers’ property.

CEO Rishi Khosla has been a vocal critic of this – taking the view that falling home ownership, as well as a rise of entrepreneurs operating in industries which don’t require property assets, has meant the property-backed lending model just isn’t workable for many new firms.

When it comes to outside investors, who you might’ve sold shares to, Sharma said: “There’s no typical security format, but they may well put in warranties to make sure the business has what it says it does” – just to protect themselves.

If you’re operating as a sole trader you are, of course, taking on all the risks, but Sharma pointed out that if you’re in a partnership “liability could be joint”, so all members involved are liable for the partnership debts in full, or in part individually – dependent usually on their ability to pay.

In insolvency, there is no protection for the partnership’s individual members as it is within limited liability company – the individual partners are liable for the partnership debts, if the partnership cannot meet them.

It is worth remembering that, while trading as a partnership can carry some tax rewards, if things go wrong (including if an individual partner becomes insolvent) a partnership can quickly become a serious burden.

Sharma flagged up “piercing the veil of incorporation” as a concern all business owners should be aware of. If a court pierces a firm’s corporate veil, the owners, shareholders or members of a corporation can be held personally liable for corporate debt. From here, creditors can go after the owners’ home, bank account and any other assets in order to meet the corporate debt.

Guarantees can, Sharma noted, “make things tough and in most instances small businesses will be asked for a personal one, even from alternative lenders”. If the bank finds the business viable, but it doesn’t have the security to match the commercial criteria, another option can be to look towards the Enterprise Finance Guarantee Scheme, backed by the government. Under it, banks are encouraged to offer loans to small businesses, with the government guaranteeing to cover up to 75 per cent of any losses, should the company be unable to repay.

This scheme has come under criticism in the past for not being transparent enough in what protection is being offered, though there is extensive information online about what it entails – the British Business Bank provides a thorough overview here.

The point to emphasise is that the 75 per cent guarantee to the lender does not mean the borrower is only liable for 25 per cent of the debt.

Whichever types of funding you have opted to pursue, Sharma advises thinking long and hard about your personal circumstances when making agreements, as well as what level of negotiation you can take with the lender.

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Bivek Sharma has been a partner with KPMG for over ten years, specialising in accounting, tax and software. He started the Small Business Accounting division over two years ago with a goal to transform accounting services for small businesses. The team works with a huge variety of industry sectors and companies including coffee shops, technology companies, manufacturers, pubs, restaurants and retailers.

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