A guide to personal guarantees for business borrowing

Signing a personal guarantee could help business owners access finance, but it could also have serious implications for their personal finances. This brief guide outlines what personal guarantees are and what the implications of agreeing to one are.

Agreeing to a personal guarantee could be a useful way to get finance your business might not otherwise be able to access.

However, it does mean you are personally liable if your business can’t repay the loan, so you must carefully understand the implications before signing an agreement.

What is a personal guarantee?

A personal guarantee is a legally binding agreement between a finance lender and a business owner or director which states that the business owner or director will be personally liable for repaying the loan if the business defaults on loan repayments or becomes insolvent.

As with any financial or legal decision, it’s always a good idea to get independent specialist advice before committing to anything.

Some lenders may request the full loan amount as a personal guarantee, while others will ask for as little as 20%.

If the loan amount is high, the lender might request multiple personal guarantees.

A personal guarantee is usually required for unsecured business loans, which you can borrow without using any business assets as security.

Unsecured loans are typically quicker to arrange than secured loans and are often easier to access by small business owners, start-ups, and sole traders who don’t have business assets.

However, unsecured loans tend to have higher interest rates than secured loans due to the higher risk involved for the lender.

Implications of a personal guarantee

There are several advantages and disadvantages of signing up to a personal guarantee.

We’ve included some in the list below.

Advantages of personal guarantees

Provide access to finance

Agreeing to a personal guarantee could mean your business gets funding you might otherwise not be able to secure.

This is particularly true for new start-ups with limited credit history or business owners with a poor credit score.

More favourable terms

If you accept a personal guarantee, the lender may offer better terms for the loan, such as lower interest rates.

Achieve business growth

Accessing finance could help you make investments and achieve your business goals.

Disadvantages of personal guarantees

Impact on your credit score

Signing a personal guarantee doesn’t affect your credit score, but if the business defaults on loan payments and you then miss personal payments, it could harm your personal credit score.

Personal finances

Personal assets such as your home, car, savings, and investments can be used to settle the business debts which could cause you financial problems.

Bankruptcy

If your business defaults on loan repayments and your personal assets aren’t enough to cover the debt, you may be declared personally bankrupt and face long-term financial difficulties.

Whilst you are under restrictions from bankruptcy or a Debt Relief Order you cannot serve as a director of a company.

Things to consider before agreeing to a personal guarantee

Before agreeing to a personal guarantee, there are several steps to consider.

1. Understand the terms

You must fully understand the terms of the personal guarantee before agreeing to it.

That includes how much you are personally liable for if your business can’t settle the debt.

2. Seek legal advice

Many financial institutions require that business owners seek legal advice before agreeing to a personal guarantee.

Some lenders will need personal guarantees to be witnessed by a solicitor who confirms in writing that the business or director has received independent legal advice with the implications of signing a personal guarantee properly explained to them.

Find a directory of solicitors on the Law Society website.

3. Personal guarantee insurance

You may consider taking out a personal guarantee insurance policy which protects your personal assets should your business be unable to meet the loan repayments.

Policies can cover up to 80% of the debt.

Several insurance companies provide personal guarantee insurance, but you should ensure that you fully understand the terms and conditions of the policy before signing up.

4. Consider alternatives

Alternative business funding solutions which might not require a personal guarantee include:

• Secured business loans – these loans require an asset from your business’s balance sheet as security
• Start Up Loans – a government-backed personal loan that charges a fixed interest rate of 6% per year
• Invoice finance– a business uses its invoices and accounts receivable as security for funding
• Asset-based lending – a business uses existing assets, such as machinery or property, as security against finance
• Angel investment – Angel investors invest their own money in a small business in exchange for a minority stake
• Grants – Funding provided by the public sector and other organisations that you don’t need to pay back.

How to negotiate a personal guarantee

Some personal guarantees apply to the full term of the loan, but it’s worth trying to negotiate an end date sooner than that if you keep up with payments.

Once the loan is approved, by making payments on time, you may be able to renegotiate the terms.

If the lender can see that you are reliable, they might agree to reduce the guarantor’s liability or terminate the guarantee altogether.

Summary

Using a personal guarantee could be a helpful way for business owners to access finance, particularly those founders without business assets that can’t be used as security.

However, given the potential impact on your personal finances, should your business not be able to repay the debt, it’s vital that you fully understand the implications of signing up for a personal guarantee.