In the world of business and finance, certain terms can seem daunting and complex. One such term that often causes confusion is “personal guarantee.”
Whether you’re a budding entrepreneur, an established business owner, or simply someone looking to understand financial jargon, this guide will break down personal guarantees into simple, easy-to-understand terms.
For a deeper, director-focused explanation and help in taking action, check our Directors’ Personal Guarantee page
A Brief Introduction to Personal Guarantees
A personal guarantee is a promise made by an individual to repay a debt or fulfil an obligation if the primary party (usually a business) fails to do so. It’s essentially a safety net for lenders or creditors, providing them with additional security when entering into financial agreements.
Understanding personal guarantees is crucial for UK business owners and individuals alike. Why? Because they can have significant implications on your personal finances and assets.
Whether you’re seeking a business loan, signing a commercial lease, or entering into a supplier agreement, you might encounter a request for a personal guarantee. Being well-informed about what this entails can help you make better financial decisions and protect your interests.
So What is a Personal Guarantee?
At its core, a personal guarantee is a legal commitment. When you sign a personal guarantee, you’re agreeing to be personally responsible for a debt or obligation if the primary borrower (typically your business) can’t pay. This means that if your business defaults on a loan or fails to meet its financial obligations, the lender or creditor can come after your personal assets to recover the debt.
In the UK context, personal guarantees are commonly used in business financing scenarios. They provide lenders with an extra layer of security, especially when dealing with small or medium-sized enterprises (SMEs) that may not have substantial business assets to offer as collateral.
Types of Personal Guarantees
Not all personal guarantees are created equal. In the UK, you might encounter several types:
Limited personal guarantees: These cap your liability at a specific amount, regardless of the total debt. For example, you might guarantee up to £50,000 on a £100,000 loan.
Unlimited personal guarantees: As the name suggests, these make you liable for the entire debt, no matter how large it grows. This type carries the most risk for the guarantor.
Joint and several guarantees: Often used when there are multiple business partners or directors. Each guarantor is individually responsible for the entire debt, not just their share. This means if one partner can’t pay, the others become liable for the full amount.
When Are Personal Guarantees Used?
In the UK, personal guarantees are commonly required in several scenarios:
Business loans and financing: Banks and other lenders often ask for personal guarantees when providing loans to small businesses, especially startups or those with limited trading history.
Commercial property leases: Landlords may require personal guarantees from company directors when leasing commercial property, particularly for new or small businesses.
Supplier agreements: Some suppliers might ask for personal guarantees to secure their position when offering credit terms to businesses.
Invoice financing: Providers of invoice financing or factoring services may request personal guarantees to mitigate their risk.
Corporate credit cards: Issuers of business credit cards sometimes require personal guarantees from company directors.
Pros and Cons of Personal Guarantees
Like any financial tool, personal guarantees come with both advantages and disadvantages.
Benefits of Personal Guarantees:
– Increased access to funding: Personal guarantees can help businesses secure loans or credit that might otherwise be unavailable, especially for startups or companies with limited assets.
– Potentially better terms: Lenders may offer more favourable interest rates or repayment terms when a personal guarantee is provided, as it reduces their risk.
Risks of Personal Guarantees:
– Personal liability for business debts: This is the most significant risk. If your business can’t pay, your personal assets (including your home) could be at stake.
– Impact on personal credit score: If the guarantee is called upon and you can’t pay, it could severely damage your personal credit rating.
– Potential loss of personal assets: In a worst-case scenario, you might have to sell personal assets to repay the debt.
Key Considerations Before Signing a Personal Guarantee
Before putting pen to paper, it’s crucial to understand the terms and conditions, ensure that you read the agreement carefully and know exactly what you’re guaranteeing and under what circumstances you might be called upon to pay.
You should also fully assess the risks involved. Consider the worst-case scenario. Could you afford to repay the debt if your business couldn’t?
Don’t be afraid to negotiate the terms, try to limit the guarantee amount or duration. You might also negotiate for the guarantee to be reduced as the loan is paid down.
Seek legal and financial advice: It’s always wise to consult with professionals who can help you understand the implications and potentially negotiate better terms.
Alternatives to Personal Guarantees
If you’re hesitant about offering a personal guarantee, consider these alternatives:
Business assets as collateral: Offering specific business assets as security might be an option, depending on your company’s situation.
Director’s guarantees: These limit the guarantee to your role as a director, potentially offering some protection to your personal assets.
Other forms of security: This could include things like a charge over book debts or stock.
Legal Implications of Personal Guarantees in the UK
In the UK, personal guarantees are legally binding contracts. If called upon, they can be enforced through the courts. Enforcement can lead to county court judgments (CCJs) or even bankruptcy proceedings against the guarantor.
Guarantors have certain rights, including the right to be informed if the terms of the primary agreement change. The Statute of Limitations in England and Wales generally gives creditors six years to make a claim under a personal guarantee (five years in Scotland).
How to Reduce Personal Guarantee Risks
If you decide to provide a personal guarantee, consider these strategies to mitigate your risk:
- Limit the guarantee amount or duration: Try to cap the amount you’re guaranteeing or set a time limit on the guarantee.
- Include release clauses: Negotiate terms that allow the guarantee to be released under certain conditions, such as when the loan balance drops below a certain level.
- Regular review: Periodically review the terms of your guarantee and try to renegotiate as your business situation improves.
Recap of Personal Guarantees Explained in Simple Terms
Personal guarantees are a common feature in UK business financing, but they carry significant risks. By understanding what they are, how they work, and their potential implications, you can make more informed decisions about whether to offer one.
Remember, while personal guarantees can open doors to financing and growth opportunities for your business, they also put your personal assets on the line. Always carefully consider the terms, assess the risks, and don’t hesitate to seek professional advice before signing on the dotted line.
Ultimately, personal guarantees are a serious commitment. By arming yourself with knowledge and understanding, you can navigate this aspect of business finance with greater confidence and security.
If you need help with a personal guarantee, we’re here to help. Please contact us today.
