If you’ve taken out commercial finance before you may have been asked by the lender to provide a Personal Guarantee (PG). But hold on … why do you need to provide a personal guarantee when you’re taking out finance for the business?
We’ve had many businesses ask us the same question; in this blog we explain the reason behind lenders asking for PGs even on Commercial Finance and why they are important for securing funding.
So let’s start with the basics … What are personal guarantees?
Personal Guarantees are a legal document stating that as a partner or executive of the business, you promise to repay the loan if for any reason the business is no longer able to pay. This means that if the business isn’t able to pay the debt, you, the individual assumes responsibility of the remaining balance.
Why do lenders ask for this?
As the lender is taking a risk on you, they need to ensure they have a way to get back their money, should something go wrong with the business. Lenders tend to ask newer businesses or those with bad credit history for a PG.
Although if your business is a limited company many lenders will also expect you to provide PGs. Any stakeholders and directors with a minimum of 20% - 25% stake in the limited business may be expected to give a personal guarantee.
As the business builds up more of a relationship with the lender they may stop asking for a PG as the lender knows more about the business and whether it can afford to pay back the loans.
When would I need to provide a PG?
Some lenders only ask for PGs on loan amounts over a certain size. The lower the amount borrowed the lower the risk. Lenders look at the risk they could be taking on to decide whether a PG is needed.
For example, the current RLS scheme the lender may ask for Personal Guarantees if the amount being borrowed is above £250,000. However, this decision is down to each individual lender.
The two different types of PGs
There are 2 different types of PG’s, limited and unlimited. A limited PG means that the lender will only ask you to pay back a certain amount of the loan, that was already pre-agreed. With an unlimited PG, if the business is unable to pay back the loan the lender will ask you to pay back the full amount of the loan. This will include interest costs and legal fees.
The important part
It’s important to make sure you are comfortable with the aspects of your PG and know what it entails. If the worse happens and the business isn’t able to pay back the lender, the responsibility of paying it back falls to you. You will need to know if the guarantee is limited or unlimited. Will they serve notice, or can they seek payment on demand? What is the length of time the personal guarantee lasts? Make sure you clarify with the lender exactly what your responsibilities are and where they begin and end.
To be transparent we need to share the cons of Personal Guarantees. While we still believe they’re important, they’re not always sunshine and happiness.
The main risks to consider with a PG are:
- You could lose your house, your car, and other personal assets
- If you’re assets don’t cover the loan amount you could be made bankrupt
- If you can’t pay the loan back, you will have to seek court permission to become a company director in the future
On the flip side putting up a Personal Guarantee could allow you to borrow a higher amount. For new businesses who don’t yet have a history, PGs provide the lenders with the security they need and the borrower with the funds they need.
A little note to end on
Personal Guarantees are important as it shows to the lenders that you back your business. You believe that your business is going to be a success, that this finance will help your business to grow and that you are willing to support your own business.
If you don’t have faith in your own business, why should a lender?
Personal Guarantees don’t come without their own risk however if you have a viable business that will continue to turn a profit it reduces the risk to you. Of course, you can’t predict the future (who saw a worldwide pandemic hitting), so you need to fully understand all your options, rates and requirements before signing on the dotted line.
We always recommend seeking advice when taking out commercial finance, whether that’s from a commercial Finance Intermediary like ABL or specialist business advisors like our partners from The FD Centre, FDS and Boardroom Advisors.