Are you one of the millions of small business owners who have secured a loan by signing a personal guarantee without realising the implications?
It’s estimated that more than 2.5 million of the UK’s 5.7 million small business owners who sign a personal guarantee are unaware that they are personally liable, with their assets potentially in jeopardy if a loan is called in. As a director, you have a responsibility to act in your company’s best interests and while incorporation allegedly provides a protective bubble around the company, that bubble can burst spectacularly if a personal guarantee has been signed.
More than half of UK small business owners don’t understand personal guarantees
With around half of UK start-ups failing within five years, personal guarantees may mitigate the lender’s risk, but they represent a huge risk across the SME community. Recent research showed 55% of SME owners were unable to describe a personal guarantee and more than 60% were unaware their personal assets are at stake. Understanding these risks is a must for any business owner who may need to sign a personal guarantee.
For the small business owner, signing a personal guarantee is often the only way to access finance for business growth.
What are personal guarantees?
Personal guarantees give the lender a written promise, made by a director or number of directors, to accept liability for a company’s debt. In practice, this means that if the business defaults on a loan (or lease) the director’s home, car and anything in their personal bank account may be at risk.
Your spouse or partner will have to sign the guarantee if they co-own the family home, so it’s vital you seek sound legal advice before making such an important commitment.
Most guarantee forms require joint and several liability. This means that each individual who signs a guarantee can be liable for the whole amount of the loan.
Guarantee costs can escalate
While the guarantee is usually capped at a certain amount, you need to bear in mind that the sum owed may be substantially more by the time interest and costs have been added. And remember, there’s no termination date for a guarantee and they’re also cumulative.
So if you, like many, believe that your incorporated business provides a nice little bubble to protect you from personal financial liability if things go wrong, you need to think again when it comes to signing a personal guarantee. That bubble could go bang.
What happens in insolvency and liquidation after signing a personal guarantee?
As a form of security for creditors, you may not realise when signing a personal guarantee that they can be called in under various circumstances, not just during liquidation. If your business is in financial difficulty or insolvent, it is worth getting specialist advice.
However, personal guarantees are a particular problem when a company is liquidated and the company cannot pay, and can result in bankruptcy. This is because a personal guarantee on business loans remains unsecured, and does not become a secured debt even when entering liquidation.
Should I sign a personal guarantee?
So, should you sign a personal guarantee? Make it a priority to find out what signing that guarantee means for you personally and if it is the only way you can get that vital business loan, consider taking out insurance to cut the risk of financial loss due to personal liability.
Currently there is only one insurer offering personal guarantee insurance to small business owners, which can be purchased for an existing guarantee, or as finance is taken out. Cover provides up to 60 per cent of the debt value in year one, rising through 70 per cent in year two to a maximum of 80 per cent in year three and premiums can be flexed depending on the policyholder’s credit rating. Throughout the policy the small business owner also has access to specialist business advisers.