The Role of a Director's Guarantee in Business

Securing your company's future requires bold moves - from expanding your operations to investing in state-of-the-art equipment. However, you often need significant funding to put these strategies in motion.

But what happens when traditional financing isn't an option? This is often the case for SMEs and fledging enterprises who lack an established credit history and collateral that banks and lenders look for.

Lenders want assurances that they will get their money back, and SMEs are often deemed too risky to take on conventional loans. Fortunately, an alternative financing option to help you access the capital you need is a personal guarantee, also known as a director’s guarantee.

A personal guarantee can be the ticket to crucial funding. And yet, it comes with a heavy price.

By signing a personal guarantee, directors put more than just their business on the line – they also put their personal assets at risk.

In this blog, we explore how signing a director's guarantee can help you access crucial funding for business growth, the potential risks and how to mitigate them.

What is a director’s guarantee?

A director’s guarantee is a legal agreement made by a director to personally repay a business loan if the company cannot meet its financial obligations.

It’s designed to offer lenders security by holding directors personally accountable for the debt.

There are two main types of director’s guarantee:

Individual guarantee

This is when a single director agrees to take on personal liability for the company's loan. If the business defaults, the director's personal assets – such as their home or savings – can be used to cover the debt.

Joint and several guarantees

This is when multiple directors are involved, each signing to guarantee to make them collectively liable. This means that if one director cannot pay, the lender can turn to another to get back the debt amount.

Why do lenders need a director's guarantee?

Director's guarantees act as an added layer of protection, especially for SMEs. While a business might not have the financial strength to secure a loan, a director's guarantee reassures the lender that they won't walk away empty-handed if the company defaults on its loan.

By tying the director's personal assets to the loan, lenders shift the risk onto the individuals, ensuring they have a greater chance of recovering the debt. Ultimately, this gives businesses access to much-needed funding while giving lenders confidence that they're not taking on the risk alone.

Key features of a director's guarantee

The most significant feature of a director's guarantee is that it makes directors personally liable for their company's debts.

As mentioned previously, if the business defaults on its loan, the director must cover the shortfall, potentially using personal assets like savings, property or other investments.

The extent of the liability varies on the type of guarantee the director has signed.

For example, a limited guarantee caps the director’s liability at a specific amount, which means the lender can only recover a percentage of the loan. For the director, this provides some protection against the personal risk of the guarantee.

On the other hand, an unlimited guarantee has no cap, which means that the director would be held responsible for the entire debt, regardless of how large the loan becomes. This ensures the lender will recover 100% of the loan amount.

It's important to be aware of which type of guarantee you are signing, as it could mean the difference between a manageable risk and full financial responsibility.

What are the benefits of a director’s guarantee?

Easier to get funding

A director's guarantee opens doors to funding that might otherwise be out of reach. For SMEs and startups, securing financing without collateral or a strong credit history can be challenging, but a personal guarantee makes lenders more willing to take the risk.

Improves credit

By securing and managing a loan backed by a director's guarantee, businesses have a chance to build up their credit profile. Over time, this can make it easier to access funding in the future without needing a personal guarantee.

What are the drawbacks?

Personal financial risks

The most obvious downside is the risk to your personal finances. Your personal assets – like your home or savings – could be at stake.

Potential impact on personal credit

A default on a loan backed by a director's guarantee doesn't just affect the business. It can also hit your credit score, making it harder for you to borrow money in the future, even for personal use.

Legal liability

Signing a director’s guarantee is a legal commitment, and if you don’t fulfil it, you could face legal action. This adds another layer of personal risk, with potential long-term consequences for both your finances and your reputation.

How to mitigate the risk of a director’s guarantee

Signing a director’s guarantee can feel like a high-wire act, but there are ways to protect yourself from a fall.

Legal guidance

Before signing anything, seek legal advice. A legal expert will help you understand the full scope of your liability, ensuring there are no nasty surprises further down the line. They will also spot any loopholes or unfavourable terms that might leave you more exposed than necessary.

Personal guarantee insurance

Just as you would insure your home or car, you can take out personal guarantee insurance (PGI) to limit your financial risk.

This type of insurance covers a portion of the debt if the business can't repay it, giving you a safety net in case things go wrong.

Beyond the business advantages, managing the risk of a director’s guarantee is important for your well-being. The stress of knowing your family home or personal savings are on the line can take a serious toll on your health. By securing protection through PGI, you can reduce that stress and gain peace of mind, allowing you to focus on your business’s success.

Negotiate terms

Don't assume the terms of a guarantee are set in stone. It might be possible to negotiate to make liability more manageable. For instance, ask for a limited guarantee that caps your personal risk.

Choosing the right PGI provider – protect your assets, grow your business

Finding the right PGI provider for your business is a serious consideration. When it comes to personal guarantees, the risks are real, but they don’t have to leave you vulnerable.

At Purbeck, understand what’s at stake, which is why we strive to provide comprehensive protection and peace of mind. As the UK's leading provider of PGI, we offer policies covering up to 80% of the assets used to secure new and existing guarantees.

When choosing a provider, directors should also look for policies backed by trusted insurers, authorised and regulated by reputable organisations.

Our policies are supported by an A-rated insurer authorised by the Prudential Regulatory Authority and regulated by the Financial Conduct Authority, ensuring our clients are confident that their personal guarantee is in safe hands.

Another factor to consider is transparency in services. At Purbeck, we arrange general insurance contracts on a non-advised basis. This means we don’t provide advice or recommendations on our products, allowing directors to make informed decisions based on clear, unbiased information.

Ultimately, your PGI provider should be able to provide expertise, security and straightforward services, delivering peace of mind so you can focus on growing your business.

If you're considering a personal guarantee, don't take the risk alone. Get in touch with Purbeck today to learn how PGI can help protect your personal assets.