What is a personal guarantee?
If your business hasn’t taken out finance before, you’ll probably come across a few new terms when you start exploring your options. It’s not always easy for small businesses to find the right funding and secure it quickly. Sometimes you’ll have to jump through a few more hoops than you might have expected. Often banks and lenders will ask for extra security before they offer finance to a smaller business. This often comes in the form of a personal guarantee.
A personal guarantee is legally binding. So, while it might seem like a no-brainer to help you secure the funds you need to grow, it’s important to look at the full picture. We’ll take you through the basics of personal guarantees and the key things to think about before signing on the dotted line. Stick around for answers to the following questions:
- What is a personal guarantee?
- Why do I need to give a personal guarantee?
- How does a personal guarantee work?
- How long is a personal guarantee valid for?
- How do I negotiate a personal guarantee?
What is a personal guarantee?
A Personal Guarantee (often referred to as a “PG”) is a form of collateral security. When a lender asks for one, they’re asking you to promise to repay the credit or debt they’ve issued if your company fails to. In other words, it’s a means of security for them in case your company doesn’t keep up with payments.
If your business falls into debt, the balance will become your personal responsibility. You’re guaranteeing to the lender that you’ll cover payments, so it’s important to understand what the implications of that will be.
Why do I need to give a personal guarantee?
It’s entirely your choice whether or not to agree to a personal guarantee. But personal guarantees offer an extra level of protection to lenders or creditors, which could help your application. They’re a way to ensure they get paid, should the company default on its commitments. Often lenders ask this of small businesses if they haven’t been trading for long or don’t have strong enough credit history. It’s fairly common, and a way of making your business a more attractive option to lend to.
The kinds of finance you might be asked for a personal guarantee for include:
- Business bank loans
- Invoice finance facilities
- Property leases
- Trade supply deals
- Asset leasing agreements
Advantages and disadvantages of personal guarantees
If things are going well and you’re looking for finance to help your business grow, a personal guarantee may not seem like a big deal. They’re a simple way to secure the funding you’re after, which you may otherwise have been denied. But when the business is struggling financially, you might be less keen to guarantee payments indefinitely.
The main advantage is clearly that they help you get the finance your business needs. It could be the difference between success and failure when it comes to accessing cash or credit. With a loan or invoice finance in place, you can fund your growth plans and take your business to new heights.
However, there are several risks that you need to take into consideration. Firstly, it’s a personal commitment. If your company becomes insolvent then the responsibility to manage your repayments falls on you. Depending on the interest rate you manage to get, that could be a huge strain financially. For some directors, it has led to long-lasting problems for their personal credit rating, and even bankruptcy. If you did have to declare bankruptcy, then you wouldn’t be able to act as company director without court approval.
Make sure you realise that what might seem entirely hypothetical could mean you being personally liable for significant debts.
How does a personal guarantee work?
The business owner or “principal” becomes a co-signer on the credit or loan application. In your contract there will be terms that spell out how a lender or creditor will enforce the guarantee. We’ll get onto these, but firstly, you should know that there are two types of personal guarantees: limited and unlimited. Here’s how the differ:
Limited guarantees allow lenders to only collect a specified amount of money, or a certain percentage of what’s left to pay if you default. You can have multiple guarantors as part of your personal guarantee, so this way you can split the responsibility. For example, you might agree to have four principles, splitting the guarantee evenly. So if your business can’t keep up its repayments, the lender can go to each principal for their 25% share of the balance.
Unlimited guarantees mean a single guarantor is liable. If your business defaults, then the lender can go after the full outstanding balance from the named personal guarantor, for example the company director. If there aren't enough liquid assets available then they can seize other assets, like your home or car.
If you default on a personal guarantee, the lender will take the asset you used as collateral. You’ll receive a letter from them containing their payment terms, which you should check against your signed loan agreement. If you don’t pay within a specific timeframe then they’re likely to start legal proceedings against you or petition for your bankruptcy.
A personal guarantee might not be enforceable if the ‘limitation period’ (usually six years after the breach of contract occurred) has passed. There are a few other reasons that might make it unenforceable. For example, if fraud has taken place, or if you were misled by the lender. Additionally, if you weren’t aware of any significant changes that had taken place with the facility then your guarantee wouldn’t be enforceable.
How do I negotiate a personal guarantee?
Before you sign a contract, make sure you seek legal advice. Here are a few questions you’ll want to know the answers to:
- Will the lender serve notice or can they seek payment on demand?
- Do terms allow for any remedy period for you to try and get back onto safe footing financially?
- What will constitute a default exactly?
- How were your net assets assessed before you sign the guarantee, and could this change?
- Do your creditors or lender need to exhaust every other avenue before seeking payment from you? If you want to negotiate any of these points, it’s always easiest done before you get into any financial distress. If your lender is open to it, then it’s best to try to cap your responsibilities while you’re drafting the contract. You might also want to add a requirement that the lender has to seize company assets before your personal ones.
On top of that, you should try to agree that you can terminate a guarantee if you wanted to leave the company.
You can also take out personal guarantee insurance after you sign. It’s designed to protect you in case the lender calls on the personal guarantee. While it might give you peace of mind, it will never cover the whole guarantee, and is another cost to consider.
What are my options?
Not every facility requires a personal guarantee. If you’re hesitant about having to be a guarantor for the loan then it might be worth exploring your options like invoice finance or a flex loan up to £100,000. Alternatively, it’s always a good idea to be open with your broker or account manager. You might be able to borrow a lower amount without a personal guarantee, so find out what choices you have before you sign anything.