For many people wanting to start (or grow) their own small business, a personal guarantee is the only way to successfully secure essential funding, but what is a personal guarantee, and is it a requirement to take our a loan for a new business?
With SME lending more than doubling over the past couple of years, many new business owners and directors are accepting personal guarantees without fully understanding the implications.
It’s important to know what a personal guarantee is, what they’re good for and the main drawbacks before you take out a loan to start your business.
What is a personal guarantee?
A personal guarantee is a written, legal promise that is made by the director (or multiple directors) of a business. Should the business become insolvent, those who signed the personal guarantee will now be liable to repay the business loan using personal assets (their home, bank account, savings, etc.).
While this sounds like an unnecessary risk that many would like to avoid taking, the majority of new SMEs will fail to fund their business if they refuse to sign a personal guarantee.
Without one, many lenders are unwilling to risk their capital, making them an essential part of early business growth.
Are personal guarantees necessary to start a business?
When starting a business, it is not always necessary to require business finance so personal guarantees are not strictly necessary to start a business. However, if finance is needed, personal guarantees can allow people to avoid loans with prohibitively high-interest rates, as the lender’s risk is reduced with the additional security.
Generally speaking, it can be advantageous to sign a personal guarantee when taking out a loan to start your new venture.
If your business is a success, great! Your interest rate will be lower, and you don’t have to pay through the nose when it comes to paying off your loan.
On the other hand, if you default on your loan, you could lose your home or other assets. This is why it’s important to take out personal guarantee insurance to cover up to 80% of your loan amount, protecting your assets should you not be able to pay your debts yourself.
What are the benefits of a personal guarantee?
There are plenty of benefits to personal guarantees, and many businesses thrive after signing one.
- Signing a personal guarantee allows lenders to provide significantly larger loans than they otherwise would be able to, as their risk is mitigated somewhat.
- Because the risk is reduced, lenders will often offer cheaper interest rates. This means that your overall costs will usually be significantly lower.
- As the market is incredibly competitive, being open to a personal guarantee allows you to shop around for the best available loans.
- If your credit score isn’t as high as you’d like, a personal guarantee is a fantastic way for you to successfully fund your new business venture.
What are the drawbacks of a personal guarantee?
It’s not all sunshine and roses. As mentioned, there are distinct risks involved with personal guarantee backed business loans:
- You could lose your home, car, savings and much more should you not be able to repay the business loan following insolvency.
- Defaulting on a loan will often involve legal action, which is both costly and time-consuming.
- In some instances, directors will have to declare bankruptcy if they cannot cover the outstanding business loan debts. This can have long-term ramifications (such as being unable to hold a director role in the future).
Personal guarantees are innately very risky, but are often the only way for budding professionals to make their vision for a business a reality.
What happens if I sell my business?
Your business is thriving, and you decide that it’s time to sell up and move on – what happens to the debt in this instance?
You will need to ensure that you’re released from your personal guarantee. If you fail to do this, you could end up liable for the company’s debts even after you sell it, so this is incredibly important!
This process usually involves you paying off the remainder of the loan as part of the sale of the business.
Personal guarantee insurance with Purbeck
Starting a new business is incredibly exciting, and it’s easy to make mistakes when emotions are running high.
It’s essential that you take the time to consider all of your options when looking for the loan that will allow your new business to thrive.
For most new businesses in the UK, personal guarantees are the best (and often only) way to secure funding. If this is the case for you, then we highly recommend taking out personal guarantee insurance.
At Purbeck, we understand that when you sign a personal guarantee, it’s far more than your signature on the line.
It can be daunting risking your home for a loan. That’s why thousands of prospective business owners have taken out insurance with us in order to protect their assets and gain peace of mind.
Focus on growing your business without the stress of your personal guarantee looming over you. Get in touch with our team today; we’re on hand to answer any questions you might have about personal guarantee insurance.