Whatever stage of growth your business is in, there may come a time when you need a fresh injection of cash and you are faced with the uncomfortable prospect of signing a Personal Guarantee.
This could be for new equipment, new people or simply to maintain cashflow. In fact we know that today, 1 In 4 SMEs[i] are planning to raise funding just to stay afloat.
For some business owners, signing a Personal Guarantee just goes with the territory of running a small business, for others it’s a source of great anxiety.
Here we explain the implications of signing a Personal Guarantee to secure funding and what you can do to reduce the risk.
What is a Personal Guarantee?
A Personal Guarantee provides security to a lender that if you default on a business loan, they can call on your personal assets to settle the debt and any interest accrued. As such, by signing a Personal Guarantee you are usually putting your home and savings on the line.
One person can sign a Personal Guarantee for a loan or it can be shared amongst several directors. The terms of a Personal Guarantee can change from lender to lender so it important to get clarity on these terms before signing on the dotted line.
Personal Guarantees – The Positives
So first the pros of a Personal Guarantee. For many small businesses, signing a Personal Guarantee is the only way to access new finance. If you are willing to accept the risk, it increases your options in terms of loan facilities considerably and gives you access to the cash you need.
It may be possible to negotiate the percentage of the loan you should Guarantee which would reduce the personal risk to you.
You may also be able to insure yourself against the risk of a Personal Guarantee being called in, to keep your personal assets safe in the future. We found[ii] that nearly three quarters of SMEs (74%) would be more likely to take out a loan with a Personal Guarantee if they could insure against the risk of providing it.
Personal Guarantees – The Negatives
And what are the cons of signing a Personal Guarantee when taking our a business loan?
The most obvious drawback is if things do go wrong and a call is made under the Guarantee, you and any other guarantors will be liable to pay the company’s debt. All your personal assets will potentially be on the line – you could lose your home, your bank account could be frozen, your savings taken to settle the outstanding debt.
You might have fantastic confidence in your business prospects today but all sorts of external factors over which you have little control, can come into play.
For example, who could have predicted the impact of the Brexit impasse on UK businesses? New legislation could render your business model worthless, a large customer goes under or refuses to pay, even the weather can play havoc with business plans.
To illustrate this point, one of our customers opened a sunbed salon, spring 2018, not anticipating that we were about to have the best summer we have had for years. Custom tailed off as the weeks of unremitting sunshine continued and sadly the business failed.
In the worst case scenario, if your personal assets fail to cover the debt, you may be made bankrupt. This has longer term ramifications as it will not only adversely affect your credit rating but you won’t be able to act as a company director without court permission.
It’s also worth remembering interest levels on large debts can soon escalate.
Even if you have a minority stake holding in the business, the whole amount can be called from one guarantor and the lender will pursue whoever they believe is most likely to settle the debt.
Needless to say this can all create immense stress for the people involved as well as their families, particularly if spouses have co-signed the Guarantee.
What can I do to cut the risk?
If you do decide to go ahead and sign a Personal Guarantee, the first priority is a thorough check on what you’re potentially getting into.
- Educate yourself about the risks, ask whether you can afford to take them and always seek legal and/or personal finance support – your accountant, solicitor or a finance broker are good sources of advice
- Work out a way that you are not solely carrying the liability – so split the Guarantee between your fellow directors
- Seek absolute clarity on where your responsibilities for the Guarantee begin and end – for example is the Guarantee loan specific or does it cover all future loans that the lender may provide?
- 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
- If you’ve signed a Personal Guarantee for another business loan previously don’t forget that they are cumulative so you could be doubling the risk to your personal assets
- Ask that the lender seeks settlement from company’s assets before enforcing the Guarantee
- Confirm all points of agreement intention and expectation in writing with the lender. This could be crucial if there comes a point when you’re trying to negotiate out of a personal Guarantee
- Consider Personal Guarantee insurance. This type of insurance policy, which is relatively new to the market, offers protection against the risk that the Personal Guarantee is called by a lender and will offset any outstanding obligations called in under a Personal Guarantee. The amount of cover is based on a fixed percentage of the Personal Guarantee you want to insure and is dependent on whether the corresponding finance facility is secured or unsecured.
Can I challenge a Personal Guarantee?
Whether you take out Personal Guarantee insurance or not, in some cases there is still scope to challenge a call on a Guarantee:
1. Material alterations
If material alterations have been made to the Guarantee after you’ve signed it and they are prejudicial to you the Guarantee may not be enforceable.
2. Key facts disclosure
If all the key facts were not disclosed at the time of signing the Guarantee, you may have scope to negotiate out of the Guarantee.
3. Undue influence
If you were subject to undue influence in signing the Guarantee, your individual circumstances and position in the company will need to be examined.
Signing a Personal Guarantee is not a decision to be taken lightly but there are ways to reduce the risk and access the finance you need to help your business survive and thrive.
About the author
This guide has been written exclusively for ByteStart by Todd Davison, Director, Purbeck Insurance Services, the UK’s only insurance provider offering Personal Guarantee insurance.
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[i] 500 SMEs surveyed by Censuswide, March 2019
[ii] 500 SMEs surveyed by Censuswide, March 2019