When making a funding application for your business, you will likely come across the term ‘personal guarantee’. A personal guarantee is often required when taking out a business loan from a lender.
It is essentially a promise made to the creditor by the debtor that, should the business be unable to keep on top of payments, the borrower will be held liable for the repayment of the loan.
There are different types of personal guarantees, as well as various legal implications associated with each. Read on to find out all you need to know about a business loan personal guarantee.
What is a Personal Guarantee?
Business loans often come with a personal guarantee requirement. Once signed, this agreement makes the borrower the official guarantor of the loan, should the business claim bankruptcy while repayments are due. When signing a personal guarantee, the borrower will likely have to disclose their credit history as well as details of their personal assets.
Personal guarantees are legally binding. The lender has the right to enforce the terms of the agreement if repayments become overdue. This could result in the debtor losing a number of their assets. In a worst-case scenario, the terms of a personal guarantee could result in the borrower losing their home.
A personal guarantee ensures that the lender is guaranteed to get their loan back. It also ensures the lender of the borrower’s confidence in their enterprise. If a borrower submits a personal guarantee, it suggests that they believe their business will succeed, which renders them a safe investment.
How Does a Personal Guarantee Work?
The terms of a guarantee can only be enforced by a lender should the borrowing company default on payments. In which case, the borrower will stop pursuing the company for repayments and instead direct their focus towards the guarantor.
It’s essential for a business owner to fully understand the implications of a personal guarantee, as it could result in them unknowingly risking their own assets to secure a loan.
Types of personal guarantees
Two of the most common types of personal guarantees you will encounter when applying for a business loan are limited personal guarantees and unlimited personal guarantees.
Limited personal guarantees
A limited personal guarantee works more favourably for the debtor, as it limits the amount that the lender can take. This type of guarantee is commonly offered to businesses with several owners or directors, where debt repayment responsibility can be shared across several guarantors. Each guarantor will only have to risk a certain percentage of their assets, as opposed to all holdings.
Unlimited personal guarantees
An unlimited personal guarantee is usually offered to a single director, who becomes wholly liable for the loan repayment. If the company files for bankruptcy, the creditor can take 100% of the guarantor’s personal assets if necessary to repay the loan.
What Types of Loans Require a Personal Guarantee?
Although not all business loans require a personal guarantee, providing one definitely increases the chances of attaining the loan. Business loans that normally require a guarantee include the following:
Business bank loan
This is a loan from a bank used to help cover the daily runnings of a business. For example, a new business may take out a business bank loan to cover the start-up cost. A business bank loan will often come with a personal guarantee to ensure it gets paid back once the business starts profiting.
Asset leasing arrangement
In this arrangement, a creditor leases out assets to a business in exchange for regular payments. A personal guarantee will likely be signed so that the lessor does not lose money.
Trade finance loan
For this loan agreement, a lender supplies a loan to cover the cost of stock or inventory. A personal guarantee might be needed to ensure that the lender receives a timely repayment.
What Types of Loans Do Not Require a Personal Guarantee?
It is difficult to attain unsecured business loans unless you are an already established business or have a perfect credit rating. A personal guarantee isn’t always necessary with business loans. However, it establishes trust and improves chances of attainment.
It’s possible to attain any type of business loan without a personal guarantee. However, without a guarantee, the size of the loan is likely to be significantly smaller and the interest rate significantly higher.
What Are the Pros and Cons of Personal Guarantees?
Pros:
- Personal guarantees help to secure funding for your business. Without establishing trust, you are unlikely to attain the loan size you require.
- By securing finance through a personal guarantee, you can establish your business and fully realise its potential. Once established, paying off the loan will be easy.
Cons:
- As the guarantor, you take full responsibility for paying back the loan. Unforeseen circumstances can arise, leaving you unable to pay back the lender. This could result in you losing your own assets, such as your home, car, or savings account.
- Failure to repay a personal guarantee can negatively impact your credit score.
Who Benefits From a Personal Guarantee?
Both the lender and the borrower benefit from a personal guarantee. To the lender, it removes the risks associated with providing a business loan. Knowing that the loan will be repaid no matter what, they are more likely to agree to provide the loan in the first place.
Without obtaining a personal guarantee, the lender will likely have to engage in lengthy legal proceedings to gain the money owed. Through carrying out such legal proceedings as court litigations and injunctions, the lender may lose even more money in legal fees. Therefore, it’s easier for them to have a personal guarantee arranged, should the debtor fail to pay them back.
On the other hand, the borrower benefits from providing a personal guarantee as it increases their chances of attaining a loan. Small businesses may not have the financial support they need to get their enterprise off the ground and may rely on attaining a sufficiently sized loan.
By providing a personal guarantee, a business can overcome the setbacks presented by having a low credit score. For a small business, providing a personal guarantee is one of the best business finance options available.
Although there is a certain amount of risk involved, both parties benefit from a personal guarantee.
How Long Are Personal Guarantees Valid for?
The length of time in which a personal guarantee is valid depends on the contract. If the guarantee is only valid for a certain amount of time, this limitation period should be stated clearly under the debtor’s obligations section of the contract. Generally, this limitation period lasts six years.
What Are the Legal Implications of Personal Guarantees?
Personal guarantees are legally binding, and each personal guarantee should clearly state a limitation period in writing. This is the amount of time a lender can use the guarantee to pursue non-payments. For this reason, it is advisable to seek legal advice before providing a personal guarantee to fully understand the implications of the contract.
If the company defaults, the creditor will most likely take legal action against the business director to procure the debt.
Some lenders even encourage the guarantor to consult a solicitor before signing the guarantee so that the borrower fully comprehends the terms of the agreement and cannot claim ignorance later on.
Is a Personal Guarantee Enforceable?
To be enforceable, a guarantee must meet the following criteria:
- Firstly, the contract must be in writing and signed by both the creditor and the debtor. The signature can be written or printed and must be signed in the personal capacity of the guarantor, not merely as the ‘CEO’ or ‘director’ of the company.
- Secondly, the creditor must be able to prove that they provided the debtor with the consideration (i.e., the loan) to enforce a guarantee. This should also include evidence of the offer made by the creditor as well as the acceptance of the loan by the debtor.
- Lastly, the document must be worded correctly and fit the terms of the agreement precisely.
When Are Personal Guarantees Unenforceable?
As aforementioned, a personal guarantee is unenforceable if legal proceedings are commenced after the limitation period stated. Other reasons for guarantees being unenforceable include:
- A guarantee is unenforceable if the document has been altered within the time since signing and without the debtors knowing.
- A guarantee can be negated if the debtor can prove that key facts and conditions were not fully disclosed to them at the time of signing.
- A guarantee could be made unenforceable if the debtor felt pressured into signing, particularly if the creditor failed to encourage them to seek legal advice prior to signing.
- A guarantee can become unenforceable if the terms of the bank or the lender have altered significantly, particularly without the debtor being made aware.
How Does Personal Guarantee Insurance Work?
Personal guarantee insurance protects the guarantor’s assets should a guarantee be enforced. Guarantee insurance normally comes in the form of an annual policy payment, which will likely cover the majority of the debt in the instance of a bankruptcy. Generally, a guarantee insurance provider will pay 80% of the debt.
The price you pay for guarantee insurance depends on the size of the business finance loan taken out.
Factors to Consider Before Signing a Personal Guarantee
On top of seeking legal advice, it is recommended to consider the following factors before signing a guarantee:
- Ensure that there is the option to terminate the guarantee with due notice in the instance of you stepping down from your directorial role.
- Understand how the guarantee defines a default payment. How long does payment need to be overdue before the creditor actively seeks the debt? There may be a specified remedy period in which the debt can be paid without repercussions.
- Determine whether the lender will take business assets before making demands on your own holdings.
- Consult a guarantee insurance provider before signing to get an idea of how much it would cost to cover the agreement.
Final Thoughts
Providing a personal guarantee is one of the best means for small businesses to obtain a substantial loan from a bank or alternative creditor. As long as repayments are made periodically to the creditor, a guarantee should have no impact on the guarantors personal finances. However, failure to do so could result in the creditor losing several assets to pay off the loan.
Before agreeing to provide a guarantee, you should consider if your company will be stable enough, in the long run, to keep on top of payments. You should also consult legal advice before signing the document and ensure that terms and conditions are made clear. Consider taking out guarantee insurance to provide your assets with an extra layer of protection.
FAQs
Are there options to get out of a personal guarantee?
Unless both the lender and the debtor reach an agreement to terminate the personal guarantee, the only way to get out of one is to file for bankruptcy. This agreement may involve certain obligations that the debtor must fulfil before the termination of the contract.
If the company director resigns, is the personal guarantee still enforceable?
A guarantee does not get automatically terminated if the company director resigns. If the business defaults, the original director is still officially personally liable for the loan repayment.
However, it is possible for a director to request a release from the guarantee upon resigning. In which case, the guarantee will still be enforceable, and the creditor will likely request for a replacement guarantor to be arranged.
Will a personal guarantee affect my credit rating?
A personal guarantee can affect your credit score only if your business defaults on loan repayments.
Is a personal guarantee legally binding?
A personal guarantee is a legally binding agreement between a debtor and a lender. A personal guarantee contract should stipulate the limitation period of the agreement, which is the amount of time a guarantee can be considered legally binding.