By, Todd Davison, Managing Director, Purbeck Insurance Services.
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 – in fact at Purbeck, we see most of the demand for Personal Guarantee Insurance coming from the alternative finance market.
In addition, loans in excess of £250,000 secured under the CBILS (Coronavirus Business Interruption Loan Scheme) may also require Personal Guarantees. It has certainly been the case that firms looking to take advantage of the preferential terms offered by the scheme have needed to weigh up the pros and cons of taking this step and some have mitigated that risk, through personal guarantee insurance for example.
As the Government’s support measures start to ease back as we head into 2021, firms looking for finance to sustain and grow their business could find their options limited unless they put their personal assets on the table as security.
Added to this, from December 2020, HMRC will be higher up the pecking order in the distribution of assets following a business failure. This may leave less funds in the pot to settle outstanding debts, increasing the risk of a Personal Guarantee being called in by a lender.
Now is therefore a good time to look at the pros and cons of signing a Personal Guarantee and the ways that risk can be cut.
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 of Personal Guarantees:
- 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. Personal Guarantee Insurance can cover existing or new Guarantees.
- It may be possible to negotiate out of a personal guarantee, but the process is difficult.
The Cons of Personal Guarantees:
- Stating the obvious, no-one can predict the future and while you might have a sound business plan, as the last 9 months have shown, events outside of your control can throw these plans into disarray.
- 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 much longer term ramifications, including prohibiting you from being a company director in the future.
- A minority stake holding in the business won’t protect you either as a lender will go after whoever has the most chance of settling the debt.
- Also, be aware that interest levels on large debts can soon escalate.
- Even the threat of a guarantee being called in can put 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 terms where you are guaranteeing a part of rather than the whole loan and that settlement is sought first from 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.
More than this, cover provides automatic access to mentoring and support services if a business gets into financial distress with the additional benefit of expert guidance at the point the debt needs to be settled. This takes a huge burden off the shoulders of the business owner.
2020 has been an incredibly tough year for many small businesses and while the Government has provided a range of support measures, in 2021 firms will need to take stock and look to re-build their finances independent of this support. If that involves signing a Personal Guarantee for access to funding, finding ways to mitigate that risk is vital. This is not just for the financial security of the business owner but for the peace of mind and headspace it creates, allowing the leaders and creators of UK SMEs to focus on making their businesses better.