There has been a great deal of scrutiny over the last few months over the demand from lenders for personal guarantees for business loans. For some small businesses securing a business loan is a matter of survival in the midst of cashflow problems, for others, it's to help support growth. In fact from our analysis, more directors applied for personal guarantee backed loans to help them achieve their growth targets in Q2 2024 than at any other time in the past three years.
So what is a personal guarantee, what are the risks and can those risks be avoided?
In essence, a personal guarantee is a promise by a director or number of directors, to pay back a loan from their own funds or personal assets. This means if the company defaults on the loan, perhaps because the business has gone into insolvency, their home, car and anything in their personal bank account could be at risk. As such, if a home is co-owned, the spouse or partner would also need to sign the guarantee. The worst-case scenario is that the personal assets aren't sufficient to cover the debt. In this case the director could face bankruptcy. Now for the positive news - those scenarios above can be avoided.
Shop around
First, shop around for finance and use a commercial finance broker to find the right finance deal to suit your needs. The NACFB is a good place to start when looking for a broker. Don't discount loans that have a personal guarantee attached though as they may offer more favourable terms. In addition, the choice of loans will be far wider if you accept you will need to sign a personal guarantee.
Cut the risk
The next crucial step is to research how you can mitigate the risk of signing the personal guarantee before signing on the dotted line. This could be one, or all of the following:
You could agree with the lender a time limit for the guarantee and a cap on the amount. Don't forget that interest will be added to the debt and this can mount up.
If you have assets in your business such as machinery, tools, hardware, ask if you can guarantee part of the loan and that settlement of the debt is sought first from these assets before enforcing the guarantee.
Talk to your co-directors if you have any, to see if they would be willing to share the guarantee and therefore share the liability.
Lastly, investigate Personal Guarantee Insurance. With this protection in place, if the business does fail, 80% of the loan will be settled by the insurance rather than the business owner's home, savings and other personal assets being called on to settle the debt. This innovative type of insurance for the owners and directors of small businesses also includes free mentoring and support services to help prevent a claim from happening, if a business gets into financial distress. Plus there is expert guidance on hand at the point the debt needs to be settled.
Don't let a personal guarantee be a burden
Ultimately, personal guarantees exist to protect lenders and are likely to remain a feature of the small business lending landscape. A small business owner will have more options if they are willing to sign a personal guarantee and more confidence to do so knowing they have taken steps to mitigate the risks.
Copyright 2024. Featured post made possible by Todd Davison, MD, Purbeck Personal Guarantee Insurance.