How a personal guarantee on a business loan works

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:

• Personal guarantee. A personal guarantee creates a so-called “secondary obligation”. This basically means that the creditor will go to the company first and will only come to you if the company can’t repay its debt. A personal guarantee is often capped to an agreed amount, but the guarantor is always liable if the company fails to repay the loan, no matter the reason.
• Indemnity. An indemnity creates a “primary obligation” to compensate a lender for its losses if the company doesn’t pay the loan back and is also in breach of certain conditions that are established by the contract (for example, if the shortfall is due to fraud). An indemnity is usually unlimited, but the liability only applies in the specific cases set out in the contract.

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

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. Looking for a business loans with no personal guarantee, 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.

Bottom line

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.

Frequently asked questions

• Does a personal guarantee affect my credit?

  It can. If your business defaults on a loan you personally guaranteed, it’ll lower your personal credit score. It might also hurt your credit score if your business is late on a repayment.

• How do I get out of a personal guarantee?

  If your company hasn’t paid off the loan yet (and especially if it’s leaning towards insolvency), you usually can’t. That’s why it’s better to do your homework before signing the contract and make sure you negotiate a reasonable cap on your liability if possible.

• What can I do if my business is insolvent and I took out a personal guarantee?

  If you find yourself forced to repay your business’s debt, you have a bunch of options – most of which will, unfortunately, impact your credit score. Learn more about them on our dedicated debt section.

• Is a personal guarantee loan the same thing as a secured business loan?

  No. A personal guarantee is not tied to an asset in the same way a secured loan is. If your business can’t repay a loan with a personal guarantee, you will be responsible for repaying the loan through any means possible – although this could mean selling personal assets. If your business can’t repay a secured business loan, your business assets could be repossessed by the lender to recoup its money.

• How long is a personal guarantee for?

  A personal guarantee usually lasts the length of time stated in the agreement. If there is a time limit, your responsibility to repay the loan should end after this time. However, it depends on the contract, so make sure you read the terms and conditions carefully and consider taking legal advice before signing anything.

• What is the difference between a directors’ guarantee and a personal guarantee?

  There’s no difference between a directors’ guarantee and a personal guarantee. They both require one or more company directors to be personally liable for repaying the loan if the business can’t.

• Do all business loans require a personal guarantee?

  No, not all business loans require a personal guarantee, but many lenders ask for one on unsecured loans as this reduces the lender’s risk. Whether a personal guarantee is required will likely depend on the business’ and applicant’s credit score, the amount loaned and the company’s trading history.

• Do you need a lawyer for a personal guarantee business loan?

  Potentially, yes. Many lenders require you to seek independent legal advice if you are signing a personal guarantee. Some lenders also ask that a solicitor witnesses your personal guarantee.