Few SMEs have enough cash within their organisation to self-fund growth. So, for many, the real option is to seek external finance.
To reduce their credit risk, lenders will often seek security over some assets of the borrower – in the case of your business, that’s you.
Signing a Personal Guarantee means that if your business becomes unable to repay a debt to the lender, you’re personally responsible. In other words, if your growth plans don’t quite come off and a claim is made under the guarantee, you (and any other guarantors) will be liable to pay the company’s debt, and your personal assets will potentially be on the line.
But is a personal guarantee legally binding? It’s crucial you know the legal position of signing a personal guarantee before you enter into an agreement that could potentially see you having to hand over personal assets as payment in the case of personal guarantee business loan default. You should seek independent legal advice where possible.
What does ‘personal guarantee’ mean legally?
Only 39% of company directors are aware that their personal assets are at risk when taking out business finance backed by personal guarantees¹. As a director, you have a responsibility to act in your company’s best interests and while incorporation provides a separate legal entity to limit your own personal liability, that protective bubble can burst spectacularly if a personal guarantee has been signed.
As a form of security for creditors, you may not realise when signing a personal guarantee that they can be called in under various circumstances, not just during liquidation. If your business is in financial difficulty or insolvent, it is worth getting specialist advice.
However, personal guarantees are a particular problem when a company is liquidated and the company cannot pay outstanding obligations owed in respect of the guaranteed sums. These obligations can then be called in by the business loan provider by way of the personal guarantee which can have significant implications for your personal estate.
Can you get out of or reduce the exposure risk of a personal guarantee?
If it comes to the point whereby the lender is seeking to enforce the personal guarantee, you should seek independent advice first as you may have grounds to challenge its validity.
A specialist will look into contractual elements such as the ‘limitation period’ – the maximum period of time allowed by the law to commence legal proceedings for breach of the contract of guarantee – and the conditions under which the agreement was signed. For example, maybe the lender failed in their duty to inform you that you should seek independent legal advice before signing?
We can’t stress enough how important it is that you have a complete understanding of personal guarantee law before you sign a lender’s agreement.
Can you mitigate your risk?
The details of a personal guarantee deal can, and often do, stipulate a cap on the extent of a director’s liabilities but this will always be far more difficult to negotiate into an agreement once a company is in a financially challenging or perilous position.
So, for directors, it is vital to consider and include a liabilities cap prior to signing a personal guarantee agreement with a lender.
To reduce your personal risk – and take a load off your shoulders – there’s Personal Guarantee Insurance, which mitigates against potential financial loss for the lifetime of the loan (review annually to assess if circumstances have changed).
With this weight off your mind, you can put all your energy into your growth strategy – and ensure you go home with a smile on your face.
¹ Purbeck Insurance, Censuswide survey of 500 SMEs, March 2019