Company directors across the UK are faced with the very same problem; in order to get a bank loan or even overdraft facility, security or collateral is required. Not many directors are keen to (or able to) offer up expensive equipment, machinery, and property that might not yet be fully paid for. And this can leave a director, looking to expand a business or venture into new markets, grappling for finances.
Another option however is that of a personal guarantee. Some lenders may even prefer personal guarantees by directors to business-owned collateral/security. A personal guarantee increases security and reduces risk exponentially for the lender.
What are Personal Guarantees by Directors?
What is a personal guarantee and what does it have to do with unsecured business loans?
When a director provides a personal guarantee in return for an unsecured business loan, it is not linked to a specific asset of the business. Instead, the director signing the personal guarantee is legally committing him or herself to paying the balance of the loan, if the business defaults on payments. By signing a personal guarantee, you are promising that in the event of non-payment, you will be personally responsible for the debt.
As long as your business keeps up with monthly repayments to the lender, there’s no way that you can personally be in a position of liability. The Gov.uk website explains how the relationship between guarantor and lender only kicks in in the event of non-payment quite effectively – read the HMRC Corporate Finance Manual here.
Types of Personal Guarantees by Directors
Many directors apply for a personal guarantee unsecured loan and have great success. Personal guarantees are a particularly attractive alternative financing option for those who don’t have collateral or have a less than perfect credit score. When the business is turning a decent profit and the market offers a lot of scope for opportunity, personal guarantees can prove an effective way of getting the much-needed cash-flow to grow and expand the business. This is helpful to applicants who have been turned away from the High Street bank.
While personal guarantees by directors for unsecured loans are becoming increasingly common, not everyone understands the legalities involved. It is important to know that there are two main types of personal guarantees typically requested by lenders. You need to read through the terms of the guarantee, before signing the agreement. Here’s what you need to know about the types of personal guarantees:
- Unlimited Personal Guarantees
What is a personal guarantee that is unlimited? These personal guarantees are often called “secured loans” or “indemnity” guarantees. When you sign this type of guarantee, you take on a considerable amount of risk. This type of guarantee means that the lender can recover 100% of the loan amount as well as additional legal fees and recovery fees incurred by the lender. In the event of non-payment, you will pay the cost of the lawyers hired by the lender to make judgement on the case and recover the loan amount.
- Limited Personal Guarantees
What is a personal guarantee that is limited? These are unsecured personal guarantees. When you sign a limited personal guarantee, there is a limit to how much you are liable for in the event of non-payment. This is particularly beneficial when business partners want to take out an unsecured business loan and split the responsibility. These personal guarantees by directors are preferred by business owners who want to know just how much they will be required to settle, in the event of the business failing.
Personal Guarantees and Unsecured Business Loans
Business directors looking for ways to grow and expand their businesses often struggle to get approval for loan applications at the High Street bank. This is usually because of a lack of collateral or security, as well as a less-than-perfect credit score. Even so, traditional banks loans are not always the best option. In the past, High Street banks were known for providing affordable business loans, but that’s not always true. The BBC even featured an article on business bank loan rates in the UK being uneconomic. When it comes to alternative financing options, unsecured business loans are a viable route to take. There’s less red tape involved than a High Street bank loan, they are typically paid out within 24 hours of approval, and historically speaking, small business lenders have a higher approval rate than the High Street bank.
Of course, directors should only apply for a business loan with the intention of repaying it. That being said, in some instances, business failure cannot be foreseen and then there’s left over debt to pay off. Personal guarantees by directors are a security set in place by lenders who wish to help businesses get off the ground and expand, without having to take on 100% of the risk themselves.
When a business loan requires a personal guarantee by a director, they are considered unsecured loans because no collateral or company assets are required to secure the loan. There’s still a considerable amount of risk for the lender and the borrower. Keep in mind that if your business fails and doesn’t have enough assets to sell and settle the loan, the creditor can sue you in order to settle the balance. It’s important for directors to complete affordability assessments to ensure that they have enough current cash flow to pay off the debt that they are applying for.
The personal guarantee is usually signed after a lender has received the loan application and pre-approved it. The unsecured loan pay-out will be subject to both parties (lender and borrower) signing the personal guarantee, and agreeing to the terms and conditions. For a personal guarantee to be an option, you will need to provide your business credit data as well as your own (this includes your financial background, credit history, and personal income and expense information).
The more personal assets you have, the less of a “risk” you will appear. Much the same, if your business has been operating for some time and has proof of turning a decent profit while already in need of expansion, there’s more chance that your loan application will be approved.
Legal Implications of Personal Guarantees
It is important to realise that personal guarantees are a risk to both parties, particularly on unsecured loans. For example, if your business fails and is unable to pay its debts, the lender could seek full payment from you (the director).
When you sign a personal guarantee, you are legally providing lenders access to your personal assets such as your savings account, real estate, property and so on. If you are unable to personally pay the outstanding amount, your personal property and possessions (such as your home, your car, and even your furniture) can be attached to cover the costs. If you still don’t have sufficient funds to cover the outstanding loan, [bankruptcy] (https://www.gov.uk/being-made-bankrupt) is the next step and that can lead to long term financial difficulties as well as a negatively affected credit score. In some instances, a court may rule the director as unfit to act as a company director in future.
It’s important to know that personal guarantee agreements are enforceable by law, as soon as the document has been signed by both parties.
Another great option for businesses looking for unsecured loans is the merchant cash advance. This alternative financing option works on the basis of a lender providing an upfront lump sum in exchange for a percentage of future credit and debit card transactions processed by the business. This requires no collateral and approval is based on the current performance of the business. If you process a lot of card payments, this could be a viable option for you.
Should I Sign a Personal Guarantee?
Feeling hesitant before getting into a hefty amount of debt is natural. The trick is to do your homework and ensure that you are applying for debt that you can in fact afford. If you are wondering whether you should sign a personal guarantee for your unsecured business loan, the first step to take is making the time to scrutinise the agreement before making any hasty decisions.
Some unsecured loans come with reasonable requirements for personal guarantees by directors, and these are the ones to sign. If you are faced with an unlimited personal guarantee and you don’t fully understand the contractual elements, it is essential to first and foremost, seek out legal advice.
You should sign a personal guarantee if you are able to be objective about your business’ financial situation and are comfortable that your business will comfortably afford the required monthly contributions to the debt.
You should not sign a personal guarantee if you are not the director or a partner in the business.
Personal guarantees by directors on unsecured business loans have changed the finance industry. This legal document (and commitment by the borrower) now makes it possible for entrepreneurs, who would otherwise have been denied financing, to get the funds they need to take their business to the next level.
If you are grappling with the idea of personal guarantees, tread cautiously, but rest assured, many lenders have reasonable contracts attached – you just have to take the time to read through them and find the agreement that works in the favour of both parties.