What is a personal guarantee?
A personal guarantee is a significant commitment made to a creditor, often a bank or alternative business lender, where you agree to take responsibility for a company’s debt obligations.
Essentially, it’s a binding agreement that if the primary party (e.g. your business) fails to fulfill its loan repayments, you, as the guarantor, will cover the debt.
This arrangement is particularly common in situations where the business itself doesn’t have sufficient credit history or assets to secure a loan.
By providing a personal guarantee, you’re offering reassurance to the lender that the loan will be repaid, either by the business or by you personally.
It’s a decision that underscores trust and responsibility, bridging the gap between the lender’s need for security and the business’s need for funding.
Understanding the implications of a personal guarantee is crucial for any business owner considering this route for securing financing. It reflects a commitment that extends beyond the business’s assets and touches upon personal financial responsibility.
What is an example of a personal guarantee?
To illustrate the concept of a personal guarantee, consider the following scenario:
Sally is the owner of a small retail store, “Sally’s Store Ltd.”. Her business requires a loan of £30,000 to replenish stock and invest in marketing. The company is relatively new and lacks a substantial credit history, making it challenging to secure a loan on the business’s credentials alone.
Sally approaches a bank for the loan, and the bank, recognising the limited financial history of Sally’s Store Ltd., requests additional security for the loan. They propose that Sally provides a personal guarantee.
In this context, a personal guarantee means that Sally agrees to be personally responsible for the loan if Sally’s Store Ltd. fails to repay it.
Sally reviews her personal assets and decides to use her house as collateral for the guarantee.
The bank and Sally enter into a formal agreement where it is stipulated that if Sally’s Store Ltd. cannot make its loan repayments, Sally will be legally obligated to repay the £30,000, putting her family home at risk.
This agreement is put in writing and legally binding, making Sally personally liable for the debt should her company default.
This example showcases how a personal guarantee serves as a risk mitigation tool for lenders, while giving the business an opportunity to apply for bank finance.
However, it also highlights the potential risk to – and loss of – personal assets, underscoring the importance of understanding and carefully considering the implications of such guarantees.
What is the difference between a guarantor and a personal guarantee?
The terms “guarantor” and “personal guarantee” are related but distinct concepts in the context of a loan.
What is a guarantor?
A guarantor is an individual or entity that agrees to be responsible for someone else’s debt or performance, under a contract, if that person fails to meet their obligations.
The guarantor acts as a form of insurance for the lender, providing an additional layer of security.
What are personal guarantees?
A personal guarantee is a specific type of guarantee where an individual (usually a business owner or executive) agrees to take personal responsibility for their business’s debts.
In essence, it’s a legal commitment that if the business cannot repay a debt, the individual will personally cover it.
In summary, a guarantor can be anyone who agrees to ensure a loan or obligation is fulfilled, while a personal guarantee specifically involves an individual’s commitment to cover business debts with their personal assets.
Are personal guarantees a risk worth taking?
Understanding the duration and extent of a personal guarantee is crucial for any company owner or director contemplating this financial commitment.
In the realm of business finance, terms like ‘personal guarantees’ and ‘director’s guarantees’ are often used synonymously. These guarantees serve as security measures for lenders, offering protection when they provide loans to businesses.
When you, as a company director, offer a personal guarantee, you’re essentially vouching for your business’s loan or credit line.
This act is sometimes referred to as ‘piercing the corporate veil,’ meaning that the separation between personal and business liabilities becomes blurred.
In such a scenario, if your company faces insolvency, the lender has the right to pursue you personally for repayment.
The duration of a personal guarantee typically aligns with the term of the loan or credit it secures.
It’s essential to fully understand the terms of the agreement, as the implications extend beyond the business’s financial responsibilities and directly impact your personal financial situation.
This decision should be made with careful consideration of both the company’s financial health and your personal capacity to assume this level of responsibility.
What are the legal considerations for business loan personal guarantees?
Before committing to being a personal guarantee for a business loan, it’s crucial to understand the legal nuances and potential impacts on your personal assets if the guarantee is enforced.
A personal guarantee in business lending involves complex legalities and significant financial implications.
Key aspects to consider include:
Nature of the Personal Guarantee
Distinguish between a guarantee and an indemnity. Unlike an indemnity, which is a primary obligation to compensate for a lender’s loss, a personal guarantee is typically a commitment to fulfill the borrower’s obligations if they default.
Ensure clarity in the contract about whether you’re acting solely as a guarantor, an indemnifier, or a combination of both.
Security Backing the Guarantee
It’s important to know whether your personal guarantee is secured. Secured guarantees often involve a charge over personal assets, like your home. This security can make it easier for creditors to enforce the guarantee in case of borrower default.
Understand the implications of securing the guarantee with your assets, as this could significantly impact your personal financial stability if the business fails to meet its loan obligations.
What are the advantages of a personal guarantee?
Providing a personal guarantee can be a risky move for small and medium-sized businesses, especially when it comes to securing financing arrangements.
Business Finance Providers
One of the primary benefits of offering a personal guarantee is the enhanced likelihood of obtaining financing (due to the risk). For many small or medium-sized businesses, this can be a decisive factor.
A personal guarantee can tip the scales in favour of approval, especially in scenarios where the business itself might not have a strong credit history or substantial assets to offer as collateral. However, the additional risk of personal losses can have far reaching ramifications that extend beyond the health of the business.
Interest Rates
Another advantage is the potential for better loan terms. Lenders may view a personal guarantee as an added layer of security, reducing their risk (and increasing their possible gain).
In response, they might offer more favourable conditions, such as lower interest rates.
It’s important to note that while these benefits can be enticing, they come with increased personal risk. The decision to provide a personal guarantee should be balanced with a careful assessment of both the potential advantages and the associated risks.
What is at risk with a personal guarantee?
While personal guarantees may facilitate access to business financing, they also carry significant disadvantages that can impact a director’s personal financial situation and general wellbeing.
Personal Financial Risk
The most evident risk associated with personal guarantees is the potential severe impact on the personal finances of owners and directors.
In typical business transactions, creditors cannot pursue directors personally for company debts. However, personal guarantees change this dynamic, making owners and directors personally liable.
Insolvency and Personal Financial Strain
For directors of companies that become insolvent, personal guarantees can lead to prolonged financial difficulties and, in extreme cases, personal bankruptcy.
Although it’s possible to negotiate resolutions with creditors, these negotiations can be complex and stressful, requiring careful and often prolonged discussions to reach a feasible solution.
Impact on Personal Credit Score
Although signing a personal guarantee doesn’t directly affect your credit score, it can become a concern if the business defaults on the loan.
In such cases, as the guarantor, you become responsible for repayment. Failure to meet these obligations can negatively affect your personal credit score.
The decision to provide a personal guarantee should be made with a thorough understanding of these risks. It’s essential to weigh the potential benefits against the possibility of severe personal financial consequences.
How do I protect myself from a personal guarantee?
Before deciding on a personal guarantee as a solution for company finance, it’s crucial for business owners and directors to explore alternative funding avenues.
The UK financial landscape offers a diverse range of financing options, many of which are tailored to the specific needs of small businesses facing financial challenges or directors seeking favourable credit terms.
Diverse Financing Sources and Alternative Lenders
The UK’s financial market provides various routes to funding, expanding beyond traditional bank loans.
These alternatives can offer faster and more flexible terms that might better suit your business needs.
Tailored Solutions for Small Businesses
Several financing options are specifically designed for small businesses.
These can include merchant cash advances, royalty-based funding, government grants, angel investment, venture capital, crowdfunding, and peer-to-peer lending, each with its own set of advantages and suitability for different business models and stages.
Reduced Personal Risk
Many of these alternative funding sources do not require personal guarantees, thereby reducing the risk to the personal assets and credit scores of directors.
This can be particularly appealing to business owners who wish to keep business, personal and family finances separate.
What happens if you default on a personal guarantee?
Defaulting on a personal guarantee can lead to significant financial and legal repercussions.
Understanding what happens in such a scenario is crucial for any business owner, director or individual who has provided a personal guarantee for a loan.
Loss of Personal Collateral
If you default on a loan backed by a personal guarantee, any asset used as collateral for the guarantee is at risk. The lender has the right to seize this asset to recoup the loan amount.
Legal Action and Bankruptcy
If the payment is not made within the stipulated timeframe, the lender may initiate legal proceedings.
This can involve suing for the owed amount or, in more severe cases, petitioning for your personal bankruptcy. Such actions can have lasting impacts on your financial stability and creditworthiness.
How enforceable is a personal guarantee?
Typically, a personal guarantee is extremely enforceable, given the legal nature of such an agreement.
There are few scenarios where a personal guarantee may be deemed unenforceable, such as:
Fraud
If there’s evidence of fraudulent activity related to the formation or execution of the personal guarantee, its enforceability can be challenged.
This could include situations where the guarantee was obtained through deceit or misrepresentation.
Significant Changes in Loan Terms
If the terms of the loan or credit facility covered by the personal guarantee change substantially after the guarantor has signed the agreement, and the guarantor was not informed or did not consent to these changes, the guarantee may not be enforceable.
This principle is based on the premise that the guarantor’s consent was for the original terms, and significant alterations without their knowledge or agreement can void the guarantee.
How long does a personal guarantee last for?
The enforceability of a personal guarantee is also subject to time constraints known as the ‘limitation period.’ This is the maximum timeframe within which legal proceedings must be initiated in the event of a breach of contract:
What is the limitation period for a standard contract?
For standard contracts, including most personal guarantees, the limitation period is typically six years.
This period begins from the date when the breach of contract occurred, which is usually the point at which the principal (the business) fails to meet its debt obligations, and the guarantor is required to fulfill the guarantee.
What is the limitation period for a deed?
In cases where the personal guarantee is formalised as a deed, the limitation period is extended to 12 years.
Deeds are often used in more formal or significant agreements and have a longer period for enforcement due to their formal and solemn nature.
Understanding the limitation period is crucial as it dictates the timeframe within which creditors must take action to enforce a personal guarantee.
Once this period lapses, the guarantee may no longer be legally enforceable, barring the creditor from initiating legal proceedings to recover the debt from the guarantor.
Guarantors should be aware of these timelines to understand the duration of their legal obligations under a personal guarantee.
Small businesses access unsecured, fast funding from Got Capital. As an alternative lender, Got Capital offers financing solutions specifically designed for and catered to the needs of SMEs.
