When contemplating your business finance options as a company Director, you might consider offering a personal guarantee as an assurance for a business loan or another source of credit. This puts you into a direct relationship with the lender, who could pursue you personally if your company goes insolvent. But is it a risk worth taking?
It can certainly be an attractive option. In times of financial security when business is good, it can be a means of attaining business finance to expand that might otherwise be denied. And the personal guarantee is not uncommon by any means.
But before you become a personal guarantor, you should know the legal basics of the contractual relationship you're entering, and the prospects and consequences of the guarantee being enforced.
What is a Personal Guarantee?
When you provide a personal guarantee to a third party creditor, usually the bank or another business lender, you're agreeing to act as guarantor for the debt obligations of another party, the principal — for example your company. That means if your company defaults on a loan repayment, you've guaranteed that you'll step up and pay instead.
Your obligation is secondary to the primary one between the borrower and the lender, so if your company doesn't have any repayments due then you can't be found in a position of liability.
Two basic features of the personal guarantee to bear in mind:
First, the personal guarantee should not be an indemnity – which is in itself a primary obligation to pay further damages to reflect a lender’s loss – and it's not contingent on the obligations of the borrower. When examining the detail of a contract that claims to be a guarantee, it's important to recognise if you will be acting as an indemnifier, a guarantor, or a mixture of the two.
Second, your personal guarantee may or may not be supported by a security, which could be a charge over your own home, and would potentially make it easier for a creditor to seek enforcement in the event of borrower default.
A personal guarantee will not be enforceable in any terms unless it's in writing and signed by the guarantor. Beware of the predicament that celebrity chef Gordon Ramsey fell foul of however, when his signature — as produced by a signature machine operated by his father-in-law — was deemed by the High Court to be effectively binding, on the basis that the father in law acted as agent throughout a long-standing business relationship. Personal guarantees that are expressed as a deed and formally delivered and with wording as to that in intention are likely to be treated as unconditional.
It's unlikely that any negotiations with a creditor seeking to enforce the guarantee will be straightforward, particularly if your company’s financial situation is drifting towards insolvency – so consider any such talks early on, because your scope for reducing your liability will be broader the better the prospects of recovery are.
One way to provide some certainty to the potential outcome should the guarantee come into play is to consider capping your liabilities at the drafting stage. It might not be possible with all lenders, but if it can be agreed it will mitigate your loss and provide reassurance.
Ensure you're comfortable with all the terms of the guarantee
- How does your contract suggest creditors will enforce the guarantee?
- Will they serve notice or can they seek payment on demand?
- What exactly will constitute a default?
- Do terms allow for any remedy period?
- How were your net assets assessed prior to the giving of the guarantee, and is this likely to change?
- Does your contract provide that creditors exhaust every other avenue before making demands on you?
Worth Taking the Chance?
Personal guarantees are certainly an attractive funding option and provided you are clear on the terms in which you are providing the guarantee, you can have contractual clarity on all eventualities. Be as objective as you can about the financial prospects of your business and its commercial value, and always remember that your guarantee is not a hypothetical assurance. Creditors can and will enforce them, and challenging their right to — or convincing a court that a term is unfair — will never be a straightforward process.
Pros and cons of giving a personal guarantee
Here’s a look at some of the key potential advantages and disadvantages of personal guarantees from a director’s point of view:
Could improve your chances of getting finance
The most obvious potential benefit of providing a personal guarantee in support of a financing arrangement is that doing so might increase the prospect of that arrangement being established. For small or medium-sized businesses in particular, this can be a very significant incentive if it might make the difference between succeeding and failing to gain access to cash or credit.
Securing finance can be positive
Securing finance can be an essential process for companies of any size and in any field. Therefore, any step that can be taken in support of this goal might be seen as positive, or even necessary. This view might be well-founded, but there’s also a clear risk that directors offering guarantees make their decisions based on best-case — and not worst-case — scenarios.
Allows businesses to reach their potential
In some instances, a personal guarantee might open up access to finance for a company in crucial ways. A small business loan, for example, might enable a growing company to achieve its potential in the short- and longer-term. But individual directors providing those guarantees should nonetheless consider carefully whether they would be comfortable with being pursued by creditors on a personal basis for loans taken out by their company.
Risk is higher
The clearest potential disadvantage associated with the provision of personal guarantees in support of company finance is that directors might see their own finances seriously impacted in very negative ways. Creditors cannot ordinarily pursue individual directors for repayment of debts, but personal guarantees open up that prospect.
It's a personal commitment
For some directors whose companies become insolvent, this can lead to long-lasting financial problems on a personal level, and potentially personal bankruptcy. With proper communication, arrangements to resolve these issues can be made between directors and their company’s creditors, but the process can be extremely testing and difficult for the individuals involved.
Other issues to consider
For company directors who are convinced that the pros outweigh the cons when it comes to personal guarantees, the details of the terms should become the primary area of focus. The aim should be to establish with as much clarity as possible what commitments are being made and what the potential ramifications could be.
Look at alternative options
However, before committing to any form of personal guarantee in relation to a company finance solution, business directors should always investigate alternative funding options that might be available. There’s a growing variety of routes to finance available to businesses in the UK, and many are specifically designed to meet the needs of small businesses that are faced with significant financial pressures, and whose directors are struggling to find the credit terms they need.
Seek out impartial experts
Whatever the specifics of your situation, if you’re looking to find funding options for your business and you’re uncertain whether or not the provision of personal guarantees could help, then it’s well worth seeking out help from independent experts. The key issue is understanding exactly what such provisions entail, and in what ways they might become relevant further down the line.
Personal guarantee insurance
Because they significantly increase risk for the borrower, personal guarantees can cause enormous stress, and could potentially have disastrous impacts on you and those you care for most. Fortunately, it’s possible to get insurance against the risk that your personal guarantee is called by a lender.
If you’d prefer not to offer a personal guarantee at all, we’ll search the market to find the finance solution that suits you best — there may be a lender out there that doesn’t require a personal guarantee for your circumstances.
We specialise in helping business owners access and understand the range of finance available to them. Although we can’t give advice on personal guarantee insurance (and don’t provide the service ourselves), we can refer you to personal guarantee insurance experts who can.
This article was written with valuable input from Hannah Newell, Corporate and Commercial LawBrief at Lawbite, and John Baird, insolvency expert at Scotland Debt Solutions.
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