Whatever level of growth your business is in, there will come a time when you will require fresh injection of capital, and you will be left with the uncomfortable thought of having a personal guarantee. For some people, such an agreement just enters the territory of running a business, for others it gets them anxious.
What does a personal guarantee mean?
It gives security to a lender, that if a business loan is not paid, your assets can be seized to settle the debt. As such, when you sign a personal guarantee, you are automatically putting your savings and home on the line. It can either be signed by an individual or by several directors.
The conditions can change from lender to lender, so it is necessary to properly understand such terms before signing.
The pros include:
1. For most businesses, signing one is the only means of getting new funding. If you are ready to accept the risk involved, it increases your chances in terms of considerable loan facilities and gives you access to the money you need.
2. You can negotiate the percentage of the loan you should guarantee, which can lower the personal risk.
3. It may be possible for you to have some insurance against the risk of having a personal guarantee, to retain your personal assets in the future. We discover that nearly 74 percent of small businesses would be likely to collect a loan with a personal guarantee if they are not sure of being able to provide it.
So when taking a business loan, what are the disadvantages of signing one?
1. The most obvious setback is if things go wrong and a call is placed under the guarantee. This will make you and other guarantors liable to the debt of the company. Every asset you own will be on the line – making it possible for you to lose your house, your personal bank account can get frozen, and your savings being used to settle every outstanding debt.
2. You might have confidence in the prospects of your business, but various external factors which you have no control over can come and play a part. For instance, you might predict the impact of Brexit on businesses in the UK, but the weather can impact business plans in hotel and leisure industries.
3. For worst case scenarios, if your personal assets don’t cover the debt, it can make you bankrupt. This has no long term ramifications as it can greatly affect your credit score, and you won’t be able to act as the director of a company without having court permission.
4. The interest rates on big debts can escalate soon.
5. Even if your stake is not large in a hotel business, the entire amount can be called from a guarantor and the lender will go after whoever they feel is likely to pay the debt. This can cause great stress for people involved, as well as their family members, especially if the guarantee has been co-signed by spouses.
How to avoid the risk?
- Learn about the risks, and know if you can afford to take them or not. Always seek legal advice from your solicitor or accountant.
- Figure out ways you do not entirely carry the liability – split the guarantee between all directors involved.
- Be absolutely care on your responsibilities – for instance, will the guarantee loan cover all future loans the lender might provide?
- Settle on a time limit for the guarantee, and remember that costs and interest and costs added to the debt can pile up.
- When signing a personal guarantee for another business loan in the past, remember that they can be cumulative. You might double the risk to your assets.
- Ensure the lender gets settlement from the assets of the company before putting the guarantee in motion.
- Put everything in writing – including the points of agreement and expectations.
- Have a personal guarantee insurance that offers protection against the risks involved. How much cover you get depends on a percentage of the personal guarantee the company wishes to insure.
Given the complicated nature of guarantee contracts, there’s no doubt that the contract has to be properly reviewed before putting pen to paper. The standards of lenders can be different from one to the other. Enforcing a guarantee can depend greatly on the behaviour of the lender and the terms of the drafted contract.