Over the next year, 61 percent of small business owners expect to expand their businesses. For many that will mean they will be in search of capital. What may surprise them is they may be required to sign a personal guarantee to secure financing.
What is a personal guarantee?
It is a legal agreement made by say a director who agrees to be liable for paying a third party’s debt such as his or her company’s business loan with the bank should the company be in the unfortunate position of being unable to pay it itself. The director is known as the “guarantor”. From a lender’s perspective, a personal guarantee makes a loan deal more secure because responsibility for paying it back falls not just to the borrowing company but to the individual directors involved as well.
The most common risks and considerations required by directors are set out in the checklist below:
- Consider whether the company itself can provide security over its assets, this may mean that a personal guarantee from the director is not even necessary.
- If personal assets are insufficient to cover the debt owed, the director could be made bankrupt and disqualified from being a company director in the future. The guarantee is a promise to repay the company’s debt, a failure to do so allows the lender to obtain judgment against the director personally as well as the personal assets.
- Most personal guarantees are repayable on immediate demand and the creditor can ‘call in’ the debt at any time at its discretion.
- If the guarantee is secured over personal assets then the bank can sell the assets to meet the debt, without needing to go to court. Often the assets include a director’s family home. In these cases, any co-owner would also need to take independent advice.
- Personal guarantee documents will also often include an ‘indemnity’ requiring all losses suffered by the lender being paid by the director. This is usually a free-standing obligation, unaffected by the discharge of the personal guarantee. Where possible providing an indemnity should be avoided.
What if you sell the business? In the event you sell your interest in a business, you need to make sure you get your personal guarantee released. If you are not properly released from the personal guarantee you will still be held liable if the lease or loan goes into default. You may be required to pay off the lease as part of the sale of the business.
Why is the spouse required to sign in some cases? For the same reason a business owner is. Since in most cases a small- or medium-sized business owners’ personal finances are co-mingled with the business, so is the spouse’s finances.
Always consider all options when looking for financing and ensure that you understand it from every angle. Contact us at Outsourced ACC for help understanding you financing options and securing the financing that’s right for you.
Written by Andrew Callister