Unsecured borrowing can be a minefield for small businesses. Since the financial crash of 2008, banks have been increasingly cautious in their lending criteria and particularly risk-averse. In many cases, they will only agree to lend if the firm’s principals offer a personal guarantee. So what does this mean – and should you agree to it?
All about personal guarantees
In simple terms, a personal guarantee is a written promise from a business owner to repay a business loan from personal funds if the company defaults. Whilst personal guarantees are unsecured, and hence do not put a specific asset at risk, the guarantor can potentially face the loss of personal possessions if the loan is not repaid.
Personal guarantees are often sought when a bank has doubts about a business’s ability to repay. Willingness to sign a personal guarantee indicates that a business owner is deeply committed to the success of the firm and is willing to stake personal wealth and assets to ensure its success. In general, banks will look to principals holding more than 20% of a firm’s equity to provide personal guarantees, so the risk could be spread across several individuals in the case of a limited company or limited liability partnership. In some cases, the lender will require the business owner’s spouse to sign the guarantee, as in law married couples own most assets equally.
When personal guarantees are a bad idea
You should be extremely careful if you are asked to sign a personal guarantee but are not a member of the company’s executive management team. A complete overview of the business’s finances and expansion plans is essential if you are to take this step; if in doubt, ask your lawyer to take a careful look at the paperwork.
You should also remember to release the personal guarantee if you later sell the business. Should you fail to do this, you could still find yourself personally liable if the company gets into financial difficulties under its new owners.
How to avoid giving personal guarantees
The simplest way to avoid giving a personal guarantee is to take out a secured asset-based loan. This means that the loan is taken out against a specific business asset, and that if you fail to repay the loan then the bank can seize ownership of the collateral. This significantly reduces the lender’s risk, and hence increases your likelihood of securing the borrowing you need.
Another option is to choose an alternative lender. Unlike banks, alternative lenders are not fixated on businesses’ credit scores and apply different criteria when granting credit – personal guarantees are not always part of the picture.
Both banks and alternative lenders can provide secured finance, so you should weigh up the options carefully and consider who can offer the best deals. If asset-based borrowing isn’t right for you and you face a sudden cash flow crisis, you could consider an emergency loan. Alternative lenders, such as Cashsolv, can provide finance in under 24 hours if they are confident you will be able to repay quickly once the business is back on its feet.
Finally, invoice finance via factoring and discounting represent effective ways to improve your business’s cash flow, without the risk of personal guarantees. In simple terms, these finance methods involve borrowing against the value of your debtor ledger – you can typically receive 85% of the value of your outstanding invoices as soon as you raise them.
The borrowing, along with any interest and charges, is repaid as soon as your clients pay, so it is in your interest to secure early payment. Factoring offers the best opportunity, as the finance company takes control of your debtor ledger and uses experienced credit control professionals to negotiate the earliest possible payment. However, some companies prefer to keep credit control in-house – either because they have a dedicated credit control team or because they are uncomfortable with customers dealing with a third party – in which case invoice discounting is the better option.