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All About Personal Guarantees for Small Business Loans

By Todd Davison, MD of Purbeck Personal Guarantee Insurance

Personal Guarantee requirements for small business loans have come under the spotlight following a Super Complaint by the Federation of Small Businesses to the Financial Conduct Authority. Here we explain exactly what a Personal Guarantee is, the pros and cons and most importantly, how to mitigate the risk.

What is a personal guarantee?

A personal guarantee is a written pledge made by a director or number of directors, to accept liability for a company’s debt should the business fail and is unable to pay off the loan. If their home is co-owned – the co-owner will also have to sign the guarantee.

Signing a personal guarantee is a major decision that increasing numbers of business founders now face, largely because lenders have become far more risk averse.

Purbeck research identified that 49% percent of small business owners either presently serve as personal guarantors for business loans or intend to undertake such responsibilities. Furthermore, according to our analysis of applications for personal guarantee insurance in Q1 2024, there has been a 49% rise in business owners seeking Personal Guarantee Insurance (PGI) for a small business loan. And most of these were for loans to simply keep their business running.*

What type of finance requires a personal guarantee?

Personal Guarantees can apply to a wide range of loan facilities including those available from P2P lending platforms – in fact, Purbeck sees most of the demand for Personal Guarantee Insurance coming from the alternative finance market. This is essentially any source of business funding other than traditional bank loans and overdrafts.

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, 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.

Whether it’s funding to start, sustain or grow a business, a Personal Guarantee shouldn’t be a barrier. Business owners should ensure they have benefited from expert, independent advice and looked at the ways they can mitigate the risk, including through Personal Guarantee Insurance.

*Purbeck survey April 2023, base 400.

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