How a personal guarantee on a business loan works
Discover what you should know before you personally back a business loan.
If you’ve been looking for a business loan, you might have come across the term “personal guarantee”. It’s a common feature of small business financing, particularly if your business is new and lacks a trading or credit history. However, it’s important to understand what a personal guarantee is and how it works before you agree to anything.
What is a personal guarantee?
A personal guarantee is a legally binding agreement between you, as the business owner or director, and a loan provider. It means that should your company default on your business loan repayments or become insolvent, you’ll be personally liable for paying back the loan. Personal guarantees are usually required for unsecured business loans, which won’t be tied to a specific asset like property or land. Many lenders ask for personal guarantees because lending to small businesses can be risky.
How does a personal guarantee work?
If your company takes out a business loan with a personal guarantee, the director pledges to be personally liable for repaying the loan in the event the company cannot.
A personal guarantee often increases your business’s chances of being accepted for a loan, particularly if you’re a new or small business with few assets. The personal guarantee offers an additional safety net for the lender, reducing the risk it’s taking on. For this reason, lenders might be more prepared to offer more money at better interest rates.
However, choosing a loan with a personal guarantee comes at a huge personal risk. If your business can’t repay the loan, you might compromise your savings or even end up with a personal bankruptcy that will stay on your credit report and impact your chances of getting credit for 6 years.
So, you need to consider your options carefully before signing up. Most importantly, you need to know what you’re signing – if you’re not sure what the contract you’ve been sent entails, it’s wise to seek legal advice.
What happens if you default on your business loan repayments?
If your business defaults on its business loan repayments, you, as the director or business owner, will be called upon to repay the loan yourself. You can do this through savings, investments or personal assets, or through any other means.
Personal guarantee vs indemnity
You may be asked to act as a guarantor or as an indemnifier when taking out a business loan. It’s important to understand what each of these means because if things were to go wrong, you’d be liable in different ways:
In both cases, checking the contract carefully is pivotal to understanding what the consequences of taking out a guarantee may be.
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What can I do to lessen the risk?
If you need to take out a business loan with a personal guarantee, there are a few steps you can take to reduce the impact it could have on your personal finances. For example:
- Negotiate a cap. It might be possible to negotiate a cap on the amount of debt you’re liable to repay under a personal guarantee.
- Consider personal guarantee insurance. Although this involves an additional cost, taking out personal guarantee insurance can help protect you from a large proportion of your liability. If you’re called on to pay the loan, the insurance policy will then pay out – typically, policies can cover up to 80% of the debt.
Pros and cons of a loan with a personal guarantee
- Increases chances of approval. A personal guarantee removes some of the risk for the lender, which could make them more willing to offer you a business loan.
- Can help you get competitive rates. Because some of the risk has been lowered, you might be able to borrow a larger amount at better rates.
- Can help your business to grow. You can use the funds to help your business achieve its goals.
- It’s a personal risk. If your business can’t repay the loan, your savings, investments, home and other assets could be at risk.
- Bankruptcy. If you can’t pay off the loan, you could be declared personally bankrupt and face long-term financial difficulties.
- Your personal credit score counts. Lenders often look at your personal credit score before agreeing to a personal guarantee. If your credit score is poor, you might be refused.
What if I don’t have a lot of personal assets?
Since a personal guarantee doesn’t require you to use any assets, such as property, you don’t necessarily need to have any to personally guarantee a loan. However, you typically need to have some sort of funds to show you can pay off the loan. You’ll also need to meet certain credit score criteria to get approved for a personal guarantee. In some cases, you might be required to submit a list of all your assets and liabilities during the application process – even if it isn’t much.
Alternatives that don’t involve a personal guarantee
There’s no way around it: personal guarantees are a huge risk that can affect you and your family. Here are some other options you might want to consider instead of taking on that responsibility.
- Secured loans. A secured business loan requires you to use your business’s assets, such as property, as security. If your business can’t pay off the loan, your lender has the right to sell those assets to recoup its money.
- Specialist lenders. Some lenders do offer small business loans without a personal guarantee, so it’s worth checking them out. However, you’re likely to be offered a higher rate.
- Alternatives to a loan. A loan isn’t the only way a business can be financed. You could also consider talking to your investors to see if you can get more funds, starting a crowdfunding campaign or applying for a government scheme. Learn more about government support for businesses.
Applying for a business loan with a personal guarantee can enable you to get hold of the funds you need to help your business grow, particularly if your business is just starting out. However, it’s crucial to consider how you would repay the loan if your business was unable to and what impact it could have on your personal finances before you agree to anything.
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