If you’ve been looking into business finance and you’re a major shareholder, this is a question you’ll need to answer. Personal guarantees are required (or preferred) in a wide variety of funding scenarios, and it’s important to understand what they imply before you enter into a finance agreement.
What is a personal guarantee?
Put simply, a personal guarantee is your promise to fulfil your business’s obligations if it can’t keep up with repayments. This puts you into a direct relationship with the lender, and means they can pursue you personally if your company defaults on the loan. In this way, personal guarantees bring your personal assets into play if the worst happens.
When you give a personal guarantee to a business lender, you’re acting as the guarantor for the debt obligations of the principal party — your business. Your obligation is secondary to the primary obligation between the business and lender, so the personal guarantee only comes into play if the business has overdue repayments.
Personal guarantees may also be supported by additional security. The common example is giving the lender a charge over your personal home, which gives them more comfort that there’s tangible value behind your guarantee should the worst case scenario arise.
However, many personal guarantees are ‘unsecured’, in that they’re not tied to a specific asset — which means they’re based on the overall net worth of the company director involved.
Pros and cons
All this legal talk might sound off-putting; and it’s certainly true that personal guarantees tend to ‘focus the mind’ of business owners considering finance. However, it’s not all negative, and there are reasons you may choose to offer a personal guarantee to help your business get ahead.
Could make the difference between a ‘no’ and a ‘yes’
The most obvious benefit of giving a personal guarantee is that it can improve your chances of getting a loan. Lenders look at the overall risk profile of the business and directors involved, and having a strong personal guarantee to offer gives them extra assurance that they’ll get their money back.
Might mean you can raise more capital
Related to the above point, you might find that your business profile alone can’t raise as much money as you’re looking for. In many scenarios, adding a personal guarantee to the equation means the lender is prepared to offer a larger loan amount.
Can be useful for newer businesses
Generally speaking, lenders will want to see at least a few years of trading history if you apply for an unsecured loan. In some cases, perhaps where an experienced business person has recently launched a new firm, the business owner might have enough personal assets to secure the loan via a personal guarantee — and it wouldn’t be possible to get funding based on the business alone because of insufficient trading history.
Higher risk for the director
Perhaps the most obvious downside of offering a personal guarantee is that it significantly adds to the risk for the directors involved. Business lenders cannot ordinarily pursue directors for repayment of the business’s debt, but offering a personal guarantee makes this possible.
It’s worth carefully considering your finances — both business and personal — before giving a personal guarantee, because if the worst does happen, it could have significant consequences for your personal finances.
It’s clear that offering a personal guarantee is not a decision to be taken lightly, and should prompt some serious consideration of your business and personal circumstances. However, in some cases it can help smaller or younger businesses get the level of funding they need to grow, that wouldn’t be possible without one.
Having said that, there are other ways of raising finance without personal guarantees, and if you find the idea off-putting they’re well worth exploring. Whichever route you choose, speak to an impartial expert before making a decision, and you’ll give your business the best chance of success.
Conrad Ford is chief executive of Funding Options, recently described by the Telegraph as “the matchmaking website for small businesses and lenders”. Funding Options has been selected by HM Treasury to help businesses find finance when they’re unsuccessful with the major banks, as part of the Bank Referral Scheme that launched in November 2016.