Tim Leonard
Duncan Ferris
When trying to secure finance for a business, a lender might ask for a personal guarantee from the owner or director of the business they are lending to. This is effectively a promise to personally make the repayments on the loan if the business can’t.
Becoming a business loan guarantor may be something you would prefer to avoid. But if you are willing to accept the conditions attached to it, the additional security that personal guarantees can give to a lender can help small businesses secure much needed funding.
What are personal guarantees?
A personal guarantee is a legal agreement between a lender and the owner of a business who is promising to be a guarantor for credit awarded to their business. The main implication of this is that the owner can be held responsible for paying back the lender what is owed using their own personal assets should the business default on its loan repayments or go insolvent.
For this reason, a personal guarantee is not something to be entered into lightly. But equally, many business owners are willing to sign up to what is often also called a “director’s guarantee” because it’s the only way they can secure the finance they need for their business.
» COMPARE: Business loans
When might I need a personal guarantee?
A personal guarantee can help lenders mitigate the risk they feel they are taking on by lending to businesses. Because of the additional safety net of being able to call on the business owner or director to personally repay the loan should things go wrong, lenders might therefore be willing to offer a loan, or a larger amount of finance, than they otherwise would.
In particular, a personal guarantee could prove important in helping newer or smaller businesses secure funding if they can’t provide the security a lender needs. In these circumstances an unsecured business loan might be a good option, but these usually require a personal guarantee.
An owner acting as a business loan guarantor might also help if a company’s credit history isn’t sufficient or good enough to make them eligible for a business loan purely on their own merit.
It’s possible a lender might request a personal guarantee for businesses interested in:
- business loans
- business mortgages
- property leases
- invoice financing
- asset leases
» COMPARE: Business mortgages
What is in a personal guarantee?
A personal guarantee should clearly outline the scope of the agreement and what lending is covered by it. For example, it might relate to one specific loan or the agreement could apply to a variety of different facilities from the same lender. This is crucial to understanding your full liability as a guarantor.
The terms should also outline the extent to which a guarantor is personally liable if their business is unable to repay any debts included within the scope of the agreement. Some guarantees have a cap on the extent to which a guarantor is personally liable.
Provisions and terms included within the agreement should be thorough, and can include terms that might change a guarantor’s obligations over time. As such, it is essential for a business owner or director to understand the full terms of any agreement before signing.
Personal guarantee pros and cons
There are a few obvious benefits of personal guarantees, as well as important risks to be aware of, too.
Advantages of personal guarantees
- It may allow small business owners to get financing if they have little credit history or bad credit.
- A lender might offer more favourable terms because of the guarantee.
- The funding can help your business grow and reach its potential.
Risks of personal guarantees
- You may arrange a loan and sign up to a personal guarantee confident of your business’s ability to repay, but there is always the risk this might change.
- Unless you are set up as a partnership or sole trader, personal assets can’t usually be pursued by creditors to settle business debts, but with a personal guarantee they may be able to if the business cannot pay.
- As a business loan guarantor, your savings, investments, home and other assets could all potentially be used to repay what is owed by the business, putting your personal finances at serious risk.
- If your assets are insufficient to cover the debts of the business, you could end up personally bankrupt.
How long does a personal guarantee last?
A personal guarantee is valid for the length of time specified in the agreement. If there is a time limit for the guarantee, a business loan guarantor’s obligation to personally cover the debts of a business should come to an end when this passes.
These limitation periods should be discussed and agreed when the personal agreement is drawn up. A solicitor can help you negotiate and make sure you understand the terms of the agreement.
It’s also worth noting that a personal guarantee can still apply to a company director, even after they have left the business that borrowed the finance for which the agreement applies. However, you can ask to be released from the obligations of your personal guarantee when leaving the company.
Can you limit your liability under a personal guarantee?
It might be possible to negotiate a cap on the amount of debt you could be liable for under a personal guarantee. It’s also important to establish which loans will be covered by the guarantee, and the situation regarding any additional credit that might be taken out from the same lender in the future.
Carefully considering all the terms and conditions of a guarantee agreement is essential. A solicitor can help you understand exactly where your responsibilities as a guarantor begin and end.
How enforceable is a personal guarantee?
Defaulting on a personal agreement may allow the lender to make a claim for any asset that was put forward as collateral under the agreement. If you don’t pay on time, you run the risk of legal action from the lender or even a petition to make you bankrupt.
If you are hoping for a last-minute reprieve, then the bad news is that the majority of personal guarantees are enforceable.
However, to check if a personal guarantee is enforceable make sure that it is:
- Written down: There must be a written copy of the agreement.
- Signed: The agreement should be signed by both the guarantor and their authorised agent.
- Clear: Terms of the personal guarantee must not be cryptic, and there should be clear evidence of offer, acceptance, consideration, intention and capacity.
Other circumstances, such as the guarantee having been signed under duress, can make an agreement unenforceable. If you are not sure, it is best to seek legal advice.
What is personal guarantee insurance?
Personal guarantee insurance can be taken out by a business loan guarantor to provide some financial protection to their personal wealth should the guarantee be called on. However, the insurance won’t ever cover the guarantee in its entirety. The cost of the personal guarantee insurance policy will vary depending upon factors such as the size of the guarantee and the assets being used as security.
You can obtain personal guarantee insurance for existing guarantees or brand new ones, while coverage can extend across multiple guarantors or guarantees.
Here are some things to consider while deciding on personal guarantee insurance:
- Price: The cost of insurance will vary depending on factors such as the sum being insured, the state of your business’s finances and the credit rating of any guarantors.
- Security: Taking out insurance might make your lender happy, as your loan will be extra secure.
- Coverage: While coverage can reach £400,000+, only a portion of the personal guarantee will ever be covered. This is typically between 60% and 80%.
- Making a claim: It is essential to understand when you can make a claim. Different policies carry various exclusions and limitations, while some might include stipulations that mean they will not pay out until a business is insolvent.
Do you need legal advice before entering into a personal guarantee?
Most lenders will want you to have independent legal advice before signing a personal guarantee. Seeking such professional advice can help ensure you are fully aware of the terms of the agreement you’re about to enter into and assist with negotiations on these terms, if necessary.
Image source: Getty Images
Dive even deeper
What is a VAT Loan?
The quarterly obligation of paying VAT returns to HMRC can be challenging for VAT-registered businesses for several reasons. VAT loans are a source of financing companies can use to avoid incurring late payment penalties by missing deadlines.
Top 6 Crowdfunding Sites UK
Raising money through crowdfunding could help you to start a business, launch a new project or expand the business to the next level. But determining the best crowdfunding platform for your business is a step that can turn crowdfunding failure into success.
What is Invoice Financing and How Does it Work?
Invoice financing can make it possible for businesses to borrow money against unpaid customer invoices. But how does invoice financing work, and is it right for your business?
Holly Bennett
George Harrison