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Home Business To sign or not to sign a personal guarantee – that is the question

To sign or not to sign a personal guarantee – that is the question

by Jessica Weisman-Pitts
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To sign or not to sign a personal guarantee – that is the question

Todd Davison, MD, Purbeck Personal Guarantee Insurance

The Federation of Small Business has made a Super-Complaint to the Financial Conduct Authority (FCA) over SME lending practices, including the use of personal guarantees on small business loans. It has highlighted the big personal risk an increasing number of business owners take to secure funding for their business. But while Personal Guarantees can prove to be a barrier to small business finance, it is also important to recognise that they give access to funding in many instances where other avenues might remain closed.  For example, personal guarantees are common among alternative lenders. With increasing attention on the use of personal guarantees by lenders, it’s a good time to look at the pros and cons. 

First, 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. Not surprisingly, a request from a lender for a personal guarantee can be a source of stress and anxiety.  Indeed, in a recent survey of 400 small business owners and managers conducted by Purbeck Personal Guarantee Insurance, 24% said they felt that managing the finances of their business had negatively impacted their mental health.

The past year has been very tough for small businesses and insolvencies have risen to levels not seen prior to the pandemic as the cost of doing business has increased.  From the cost of servicing finance to fuel – 2024 will be a make-or-break year for many small firms. Tellingly, the vast majority of the personal guarantee-backed loans (47% as of Q3 2023) we support are for working capital to keep the business going.

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So what happens if a personal guarantee is called in because the business has defaulted on a loan? Essentially the director’s home, car and anything in their personal bank account could be used to settle the outstanding debt.  In the worst-case scenario, if the personal assets aren’t sufficient to cover the debt, the business owner could find themselves facing bankruptcy.  This could have long-term emotional and financial ramifications and stop them from being a company director in the future. 

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.  To prove that point, the number of SME owners securing personal guarantee insurance (PGI) for a business loan doubled in September 2023 compared to the same month in 2022 and Q4 2023 saw the highest number of applications Purbeck Personal Guarantee Insurance has received in its history.

Signing a personal guarantee is a very personal decision – everyone has their own attitude to risk – but it may limit finance options if a company owner is unwilling to take that step. The good news is that there are ways to make that decision easier.

 

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Personal Guarantee Insurance is certainly one way a personal guarantee can be mitigated. With this relatively new type of insurance in place, if the business does fail, 80% of the loan would be settled by the insurance rather than the business owner’s home, savings and other personal assets being called on to settle the debt. There would also be mentoring advice and support at the point the debt needs to be settled, taking a big burden off the shoulders of the business owner at what can be a very stressful time.

In addition, if the business has a number of co-directors it might make sense to share the guarantee amongst this group. It could also be worth asking the lender if a time limit can be agreed for the guarantee or if a cap could be set on the amount.  The downside of this strategy is that as interest rates rise, the costs added to the debt will also rise.

Exploring whether a lender would agree to part of the loan rather than the whole loan being guaranteed could also help mitigate potential personal losses.  The business owner would need to show what assets within the company could be used such as machinery, tools, or computer equipment. If this approach is accepted by the lender the settlement of the debt would be sought first from the company’s assets before enforcing the guarantee. 

Finally but perhaps more importantly, seek independent, expert advice from a solicitor or accountant. Our research has shown that accountants are the small business’s number one ally when it comes to financial support.

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Like any risk in life, balancing the pros and cons of signing a personal guarantee for a business loan is essential. It could help a business fly and reach its true potential but it could also create a huge amount of worry. Making that decision comes down to being realistic about the financial risks and knowing exactly what can be done to limit them.

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