It is common practice for lenders to mitigate risk on small business loans by making it a condition that the director provides a personal guarantee.
A personal guarantee makes the director liable for the business’s debt in the event the business becomes unable to repay it. The director is known legally as the ‘guarantor’ and it is the guarantor who becomes liable for unpaid debt in the event the business can no longer afford to make repayment.
Do I need to provide a personal guarantee?
Not necessarily. While it is common practice for lenders to request a form of personal guarantee on new small business loans, this is not the only form of repayment security lenders can generate. Some do always request a personal guarantee, but others are happy to lend based on creditworthiness only.
In the case of established companies with good credit and business-owned assets, it is rare for a personal guarantee to be required on a loan. Typically, companies with good creditworthiness can borrow without guaranteeing loans personally. This one of the perks of operating a successful and reputable business.
What you pledge
A personal guarantee may be requested with a secured or unsecured loan.
What you pledge will depend on the value of the loan and the lender. You may have to pledge specific assets, such as your home or car. However, you can provide any asset as security so long as the lender is happy to accept it. Sometimes, no asset is necessary if you have a high income and are capable of repaying.
It’s important to remember that some lenders use a lien. This is a legal mechanism that gives the lender the right to keep possession of property belonging to the guarantor until debt is discharged. This is common practice.
What are the benefits of a personal guarantee?
If your business is new or has a poor credit score, then it is far more likely to be approved for a business loan if you provide a personal guarantee to take on the debt in the event your business cannot repay it.
Lenders are well versed in risk mitigation and personal guarantees provide them with an avenue to recover debt in the event of business insolvency. In simple terms, lenders are more willing to lend to those who guarantee repayment personally.
What are the downsides of a personal guarantee?
The downsides of a personal guarantee on a business loan come into play in the event of business insolvency. The most obvious downside is the guarantor becomes liable for the debt in its total form. What this means is if the lender can’t recover debt from the business, then they will seek repayment from the director or other specified guarantor. Depending on the agreement, this could mean the lender taking control of assets.
The bottom line here is personal guarantees do carry risk and you must be aware of these before signing on the dotted line. We advise all our customers to seek independent financial advice before taking out such a loan.