Your business is growing but you need more cash to take it to the next level. There are a number of funding options for small businesses but what many have in common is the need for the business owner or directors to sign a personal guarantee. In fact, the rumoured replacement for the Government’s Recovery Loan Scheme is expected to require a personal guarantee from the applicant. Some business owners will take this commitment in their stride while others will actively avoid it, limiting their funding options as a consequence. However, Personal Guarantee risks can be mitigated in a number of ways, not least through personal guarantee insurance, a relatively new type of insurance for small businesses which is already protecting over a thousand business owners across the UK.
What is a personal guarantee?
A personal guarantee gives the lender a written promise, made by a director or number of directors, to accept liability for a company’s debt. This means that if the business defaults on a loan, the director’s home, car and anything in their personal bank account could be used to settle the outstanding debt. If they co-own their home, with a spouse or partner – they will also have to sign the guarantee.
In the worst scenario, if the personal assets aren’t sufficient to cover the debt, the business owner could find themselves facing bankruptcy which would have long-term ramifications and stop them from being a company director in the future.
It’s important to understand that a lender will go after whoever has the most chance of settling the debt so a minority stake holding in the business won’t offer protection.
As the last two years have shown, many factors outside of a business’s control can impact performance so signing a personal guarantee is a decision that should never be taken lightly.
What type of finance requires a personal guarantee?
Personal Guarantees can apply to a wide range of loan facilities including those available from P2P lending platforms – in fact at Purbeck, we see most of the demand for Personal Guarantee Insurance coming from the alternative finance market.
How to cut the risk
Before deciding whether signing a personal guarantee is right or wrong, business owners should get some independent advice. An accountant, solicitor, commercial broker or financial adviser can help work out the best options for the business and advise on the additional ways the personal risks can be cut when signing a personal guarantee.
Come to an agreement to share the guarantee with co-directors. This makes the commitment much more equitable within the leadership team.
Work out with the lender if a time limit can be agreed for the guarantee and a cap on the amount but bear in mind that interest rates are already rising and costs added to the debt can soon mount up.
Talk to the lender to see if part of the loan rather than the whole loan can be guaranteed and that settlement of the debt is sought first from the company’s assets before enforcing the guarantee. Clearly, in this instance the business owner will need to show what assets within the company could be used – this could be machinery, tools, or computer equipment.
Last but not least, consider Personal Guarantee Insurance to mitigate the risk. This means if the business does fail, 80% of the loan will be settled by the insurance rather than the business owner’s home, savings and other personal assets being called on to settle the debt.
The level of cover is based on a fixed percentage of the personal guarantee the company director wishes to insure. This is dependent on whether the corresponding finance facility is secured or unsecured.
Personal Guarantee Insurance also does a lot more than payout following a claim. Policyholders are offered access to free mentoring and support services if the business gets into financial distress, plus the huge benefit of expert guidance at the point the debt needs to be settled.
64% more likely to sign a personal guarantee if there was insurance in place to cut the risk
In a survey of 1000 small business owners Purbeck Personal Guarantee Insurance conducted last year, 45% said they had decided against a loan because it required a personal guarantee. However, 64% said they would be more likely to sign a personal guarantee if there was insurance in place to protect against the risk of providing it[i].
Whether it’s funding to start, sustain or grow a business, a personal guarantee doesn’t have to be a barrier. Business owners should ensure they have benefited from expert, independent advice and taken advantage of the numerous ways in which they can mitigate the risk, including through Personal Guarantee Insurance.
Todd Davison, MD, Purbeck Personal Guarantee Insurance
[i] Survey commissioned by Purbeck, April 2021, conducted by Cision. 1000 Directors and Owners running businesses employing 250 people and under.
Feature Image Photo by Signature Pro on Unsplash
