The words ‘personal guarantee’ strike fear into the hearts of some business owners. Horror stories of houses being repossessed and families being forced onto the street mean many entrepreneurs won’t consider signing a personal guarantee when taking on finance, even if it’s the best option available to them.
But are personal guarantees really all that bad?
What is a personal guarantee?
A personal guarantee is a legal document signed by an executive of a company (usually a shareholder or director) when taking out a business loan. Signing a personal guarantee means you are responsible for paying back a loan should the business be unable to.
People often wrongly assume that unsecured loans will not require a personal guarantee. In fact, finance companies, including Esme and Funding Circle, will generally ask for a personal guarantee before granting an unsecured loan.
Personal guarantees are often requested from younger trading businesses who may not have a large value of assets within the business.
Why do lenders ask for a personal guarantee?
Personal guarantees are there to put lenders’ minds at ease. Like handing over your credit card when you start a bar tab, personal guarantees give lenders some leverage when loaning large amounts of money.
A common misconception is that lenders want to use personal guarantees to acquire your property. In reality, the hefty legal fees involved with repossessing property mean lenders want to avoid this scenario as far as possible. If your business does get into trouble, lenders will work with you to organise a manageable repayment plan.
How does a personal guarantee work?
Any business that wants to take out a loan must first make a credit application to a lender. The application will include your business plan, financial statements, projected profits and an audit of company assets.
There are several finance options available to smaller businesses. Visit Fluidly’s funding page to instantly see tailored options for your company.
Once you’ve made your application, the lender will begin an evaluation of your personal credit history, and the history of your company. For this reason, it is a good idea to review your credit score before making your application.
If your business has no high-value assets, you might be offered an unsecured loan. In this case, the lender will ask you to sign a personal guarantee, either for the full amount of the loan or a percentage of it.
You are more likely to be offered a loan under a personal guarantee if you are a homeowner. But people who do not own their home can also sign a personal guarantee. However, in this scenario lenders are more likely to restrict the amount that you can borrow.
If your business is asset rich, the lender may ask for a debenture instead of a personal guarantee.
What is a debenture?
A debenture can be signed as an alternative, or in addition to, a personal guarantee. It is a legal document that gives the lender first refusal over your business’ assets should your company collapse.
Signing a debenture will ensure the lender makes a claim on the company’s assets before asking you to repay the debt from your personal funds.
What are the pros and cons of a personal guarantee?
The advantage of a personal guarantee is that it allows business owners to gain funding even if their company has no pre-existing assets or credit history. This makes it a great option for younger trading and less asset rich businesses, especially in the current economic climate, where uncertainty has made it harder than ever to secure funding.
The disadvantage of a personal guarantee is that it makes business owners fully liable for their company’s debt. Business loans are often significant, and repayments that were manageable for a healthy company can be overwhelming for an individual. What’s more, the nature of a personal guarantee means that business owners can find themselves in a significant amount of debt just after they have lost their main source of income following the failure of their company.
Is a personal guarantee right for me?
The first thing to consider if you’re thinking about taking on finance is whether or not you feel your business will be able to repay the loan.
Crucially, this is also what lenders will assess when deciding whether to grant you funding. If a reliable financial company has offered you a loan, you can feel assured that they believe in your business goals and trust that you will be able to repay the debt from future company profits.
There are always risks involved when taking on finance and no matter which funding option you choose there will be financial repercussions if your business cannot repay its debts. It is important that entrepreneurs evaluate these risks and make informed financial decisions based on honest projections.
But personal guarantees needn’t be viewed with particular suspicion. From the lender’s perspective, they act as a reassurance that you have confidence in your company’s future finances.
For more information on how to secure funding for your company, visit Fluidly’s funding page.