Tax & admin · 16 December 2019

The pros and cons of signing a personal guarantee

signing

Signing a Personal Guarantee to secure access to funding can be one of the most daunting aspects of running a small firm. All the risk is on one or possibly a small group of individuals willing to put their homes and life savings on the line for the sake of their business.

Personal Guarantees can apply to a wide range of loan facilities including those available from P2P lending platforms.

But currently, a lot of the demand for Personal Guarantee Insurance is coming from the alternative finance market.

For some, it’s all part of the risks involved in being the owner of a small firm, for others, it’s a step too far. With countless news reports of small businesses under severe financial pressure due to the uncertainty caused by Brexit, it’s worth looking at the pros and cons of signing a Personal Guarantee.

What is a Personal Guarantee?

Personal guarantees give the lender a written promise, made by a director or number of directors, to accept liability for a company’s debt.

In practice, this means that if the business defaults on a loan the director’s home, car and anything in their personal bank account could be called on to settle the outstanding debt.

If you co-own your home, with a spouse or partner – they will also have to sign the guarantee.

This underlines the importance of seeking sound legal advice before making such an important commitment.

Most guarantee forms require joint and several liability. This means that each individual who signs a guarantee can be liable for the whole amount of the loan.

The Pros:

• Right now, funding options for small businesses are not in short supply and the SME Finance Charter has put pressure on lenders to maintain access to funding, but a Personal Guarantee will make it significantly more likely that you will get that loan.  If you decide you are willing to sign on the dotted line, you will find your options for financing open up considerably.

• For small or medium-sized businesses without the necessary capital in their business, access to finance fast can be the difference between success and failure.

• You may well reach the conclusion it’s a risk worth taking to get that finance.  If you do, it may be possible to negotiate the percentage of the loan you should guarantee.

• The risks can also be cut significantly by taking out insurance which incrementally mitigates against potential financial loss over a three year period – up to 80% of the cost of the debt.

• It may be possible to negotiate out of a personal guarantee, but the process is difficult.

The Cons:

• Stating the obvious, we can’t predict the future and while you might have a sound business plan, events outside of your control can throw these plans into disarray. (Dare I mention the ‘B’ word again?)

• If in the worst case you do default on the loan and a claim is made under the guarantee, you and any other guarantors will be liable to pay the company’s debt and all your personal assets will potentially be on the line.

• You could even find yourself facing bankruptcy if your personal assets don’t cover the debt. This obviously has many longer-term ramifications, including prohibiting you from being a company director in the future.

• A minority stakeholding in the business won’t protect you either as a lender will go after whoever has the most chance of settling the debt.

Be aware that interest levels on large debts can soon escalate

• Even the threat of a guarantee being called in can put an intense strain the guarantor as well as their family, especially if spouses have co-signed the guarantee. How to mitigate the risks

• Always get some independent advice – your accountant, solicitor, commercial broker or financial adviser can all help you work out what is right for your business and advise on the ways you can cut the personal risks you might face by signing a personal guarantee.

• If you run your business with co-directors, come to an agreement to share the guarantee.

• Negotiate a time limit for the guarantee and a cap on the amount, but do remember interest and costs added to the debt can soon mount up.

• Agree on terms where you are guaranteeing a part of rather than the whole loan and that settlement is sought first from the company’s assets before enforcing the guarantee.

• Consider Personal Guarantee insurance. Just like any other insurance, it protects against the risk of the worst happening – in this instance the risk that your business fails and the guarantee is called in by the lender.

Insurance will offset any outstanding obligations called in with the level of cover based on a fixed percentage of the personal guarantee the company director wishes to insure. This is dependent on whether the corresponding finance facility is secured or unsecured.

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