As a business owner in the UK, securing financing is often a critical step in growing your enterprise. One common requirement from lenders is a personal guarantee. This guide will help you understand what these are, how they work, and the implications for your business and personal finances.
What is a Personal Guarantee?
A personal guarantee is a legally binding agreement between a business owner (or director) and a lender, stating that the owner will be personally liable for repaying the loan if the business defaults. This means that if your business cannot meet its debt obligations, you, as the guarantor, must repay the loan from your personal assets.
Why Do Lenders Require Them?
Lenders request personal guarantees to reduce their risk. By taking this security the lender has an additional layer of comfort, knowing that they can recover the loan amount from the guarantor if the business fails to repay. This increased security often makes lenders more willing to provide financing, especially where the assets of the business itself don’t give the lender enough comfort on their own.
How a Director’s Personal Guarantee Works
A director’s personal guarantee is an agreement where the director pledges to be personally liable for repaying a loan if the company cannot service the debt. This provides the lender with an additional layer of security and shows the lender that the director believes in their business. In cases where multiple directors provide guarantees, it is known as a joint and several personal guarantee, meaning each director can be held responsible for the full loan amount.
Common Scenarios
- Business Loans: Lenders often require personal guarantees for business loans.
- Commercial Leases: Landlords may request guarantees to ensure rent payments are made, particularly for new businesses.
- Asset Finance: When leasing expensive equipment, lenders may require a guarantee to secure the lease.
- Invoice Financing: Lenders may require personal guarantees when providing financing against outstanding invoices. This will often be limited to 10%-20% of the facility limit.
- Trade Credit: Suppliers may request guarantees to ensure payment for large orders.
Are Personal Guarantees Legally Enforceable?
Yes, they are legally enforceable if the contract has been completed properly. The guarantee must be in writing and signed by the guarantor. If the business defaults, the lender can pursue the guarantor’s personal assets to recover the debt. It is crucial to understand the terms and conditions of the guarantee and seek legal advice before signing.
Personal Guarantee Insurance
Personal guarantee insurance can help mitigate the risks associated with personal guarantees. This insurance covers a portion of the debt if the business defaults, reducing the financial burden on the guarantor. While it does not eliminate the risk entirely, it provides some protection and peace of mind. It is essential to understand the coverage and exclusions of the policy before purchasing.
Alternatives to Secure Business Financing Without a Personal Guarantee
- Secured Loans: Offering business assets as security can sometimes eliminate or reduce the need for a guarantee.
- Equity Financing: Selling shares of your business to raise capital. This doesn’t require repayment but does dilute your ownership.
- Government Grants and Subsidies: Non-repayable funds from government or private organizations. These can be competitive and may come with specific requirements.
- Bootstrapping: Using personal savings or reinvesting profits to fund growth. This avoids debt but may limit the speed of your expansion.
Read up on other finance options without providing a personal guarantee.
Conclusion
Personal guarantees can be a valuable tool for securing business financing, but they come with significant risks. As a business owner in the UK, it’s crucial to weigh the benefits against the potential downsides and to fully understand the implications before committing. By carefully evaluating your options and seeking professional advice, you can make an informed decision that supports your business’s growth and success.