Todd Davison, MD, Purbeck Personal Guarantee Insurance
The UK Government has confirmed it is extending the Recovery Loan Scheme for a further two years. For some small businesses this will be welcome news, for others less so given the strict qualifying criteria. But whatever the source of a small business loan, the high likelihood is that the business owner will need to sign a person guarantee. This means they are committing to accepting liability for their company’s debt should their business fail. This comes at a time when many small businesses are already dealing with rising energy costs, labour shortages, late payment and on-going supply chain issues that contrive to make cashflow predictions very difficult.
How many businesses have confidence in their cashflow to know with a good amount of certainty they won’t default on the loan? There are so many elements that are outside a business’s control – who could have predicted Covid or the impact of the Russia/Ukraine conflict on the price of fuel? For some, signing a personal guarantee is part and parcel of the risks involved in starting and running a business, sometimes you just have to take a punt. For others making this kind of commitment is a source of great stress and anxiety. The good news is that there are ways to mitigate the risks.
What is a personal guarantee?
A personal guarantee gives the lender a written promise, made by a director or number of directors, to accept liability for a company’s debt. This means that if the business defaults on a loan, the director’s home, car and anything in their personal bank account could be used to settle the outstanding debt. If they co-own their home, with a spouse or partner – they will also have to sign the guarantee.
If the personal assets aren’t sufficient to cover the debt, the business owner could find themselves facing bankruptcy which would have long term ramifications and stop them from being a company director in the future. It’s also important to understand that a lender will go after whoever has the most chance of settling the debt so a minority stake holding in the business won’t offer protection.
What type of finance requires a personal guarantee?
In addition to the Recovery Loan Scheme for loans over £250,000, Personal Guarantees can apply to a wide range of loan facilities including those available from P2P lending platforms – in fact Purbeck sees most of the demand for Personal Guarantee Insurance coming from the alternative finance market.
How to cut the risk
- Before deciding that signing a personal guarantee is right or wrong, business owners should get some independent advice. An accountant, solicitor, commercial broker or financial adviser can help work out the best options for the business and advise on the additional ways the personal risks can be cut when signing a personal guarantee.
- Come to an agreement to share the guarantee with co-directors.
- Work out with the lender if a time limit can be agreed for the guarantee and a cap on the amount but bear in mind that interest rates are rising and costs added to the debt can soon mount up.
- Investigate if part of the loan rather than the whole loan is guaranteed and that settlement of the debt is sought first from company’s assets before enforcing the guarantee. Clearly in this instance the business owner will need to show what assets within the company could be used – this could be machinery, tools, computer equipment.
- Consider Personal Guarantee Insurance to mitigate the risk. This means if the business does fail, 80% of the loan will be settled by the insurance rather than the business owner’s home, savings and other personal assets being called on to settle the debt.
The level of cover is based on a fixed percentage of the personal guarantee the company director wishes to insure. This is dependent on whether the corresponding finance facility is secured or unsecured.
Personal Guarantee Insurance also does a lot more than pay out following a claim. Policyholders are offered access to free mentoring and support services if the business gets into financial distress, plus the huge benefit of expert guidance at the point the debt needs to be settled.
Whether it’s funding to start, sustain or grow a business, a Personal Guarantee shouldn’t be a barrier. Business owners should ensure they have benefited from expert, independent advice and looked at the ways they can mitigate the risk, including through Personal Guarantee Insurance.