When securing business funding, lenders may ask you, as a director, to provide a personal guarantee. This is a legally binding promise to repay the credit your business takes out if the business itself cannot meet its obligations. While it can be an effective way to secure funding, agreeing to a personal guarantee is a significant decision that should not be taken lightly. Here, we explore when personal guarantees are required, how they work, and what you should consider before committing.
What is a personal guarantee?
A personal guarantee is a form of security used by lenders when asset-based collateral is unavailable. Essentially, it means that if your business cannot repay the loan, you are personally responsible for the debt. This responsibility could involve using your personal assets, such as property, savings, or other valuables, to cover the repayment.
For lenders, a personal guarantee offers reassurance, particularly for unsecured loans where no physical assets are pledged. It’s commonly used for:
- Unsecured business loans: These loans don’t require collateral but often rely on personal guarantees.
- Invoice finance arrangements: Some lenders, especially in high-risk industries like construction, may require a personal guarantee.
How do personal guarantees work?
When a personal guarantee is in place, lenders assess your overall net worth, including your assets and credit history. The guarantee may cover either the entire loan amount or a capped proportion of it, though full guarantees are more common.
If your business defaults on its repayments, the lender can enforce the personal guarantee, which may result in the repossession of personal assets to recover the outstanding debt. This is why it’s essential to fully understand the terms before signing.
Should I agree to a personal guarantee?
A personal guarantee can open doors to funding opportunities that may otherwise be unavailable, particularly for new or growing businesses without a long trading history. By offering this guarantee, you demonstrate commitment and reduce the lender’s risk, which can result in more favourable terms or access to higher loan amounts.
However, there are significant risks:
- Asset loss: If the business defaults, personal assets can be seized.
- Financial pressure: You are personally liable for the debt, which can add stress to your personal and professional life.
Key considerations before agreeing to a personal guarantee
Before signing a personal guarantee, evaluate the following:
- Understand the terms: Know exactly what you’re agreeing to, including whether the guarantee covers the full amount or is capped.
- Consider alternatives: Explore other financing options that may not require a personal guarantee. The growing funding market offers tailored solutions for small businesses.
- Assess your risk: Ensure that your business’s cash flow can realistically cover repayments to minimise the chance of default.
- Seek professional advice: Consult with a legal expert or financial adviser to fully understand the implications.
Personal guarantee insurance
For additional protection, you may consider personal guarantee insurance. This type of policy can cover a portion of the debt—typically between 60% and 80%—if the guarantee is called in. While it doesn’t eliminate the risk, it can provide peace of mind and reduce the potential financial impact on your personal assets.
Is a personal guarantee right for your business?
Deciding whether to provide a personal guarantee depends on your business’s financial stability, the terms of the funding, and your personal willingness to accept the risk. While it can be an effective way to secure much-needed capital, it’s essential to weigh the potential benefits against the risks carefully.
By fully understanding the terms and seeking professional advice, you can make an informed decision that aligns with both your business goals and personal circumstances.