What is a Personal Guarantee and Does It Make Me Liable?April 19, 2018
“I signed a personal guarantee for a company loan and now the bank is asking me to repay it!”
Unfortunately, this is something we hear quite often from directors who have signed personal guarantees for company borrowing only to have their company fail and its creditor turn to them for repayment.
In this article, I’ll discuss what a personal guarantee is, its advantages and disadvantages, and what you can do if you have become liable for a debt through a personal guarantee.
What is a Personal Guarantee?
A personal guarantee is a promise by an individual to act as guarantor for the debt obligations of a company. In practice, that means an individual agrees to become personally liable for a company’s debt should the company become unable to pay it.
Here is a typical scenario involving a personal guarantee.
Picture a young entrepreneur named James. James wants to expand his new business but lacks the funds to do so. He goes to the bank and applies for a small business loan.
The bank, wary of lending money to a new business, agrees to issue the loan but asks James to sign a personal guarantee for the debt. Confident of his business, James signs the personal guarantee.
So James is now personally liable for the debt should his company become unable to repay it.
What are the advantages of a personal guarantee?
Many hundreds — possibly even thousands — of business owners sign personal guarantees for company debts every year.
The reason they do so is simple. Personal guarantees open potential routes to finance that would not otherwise be accessible. Providing a personal guarantee reduces the risk to the lender, which should result in the cost of the borrowing (arrangement fees and interest) being lower.
Think about James’ loan from earlier.
The bank requested James sign a personal guarantee to minimise its risk. If James refused to sign the personal guarantee, the bank could easily have rejected his application as being too risky.
In James’ situation, the alternative isn’t all that bad. Without the loan, he wouldn’t get to expand his business as early as he would have liked but the core business could continue running.
However, now imagine James’ business was struggling and he needed new money to continue operations. In this situation, the difference between securing a loan and not securing a loan is the difference between the success and failure of his business.
What are the disadvantages of a personal guarantee?
The main disadvantage of a personal guarantee is also very simple. If your business becomes unable to pay its debt, you become personally liable for it. That means your company’s creditor can pursue you personally and that puts your personal assets (including your home) at risk.
Unfortunately, the practical implications of a company's failure often make the fallout from personal guarantees much worse.
First, debts that were manageable for businesses are often too large to be manageable for individuals.
Second, some directors rely on just one business as their sole source of income. So if that business goes bust, their sole source of income disappears. If this happens, the director suddenly becomes liable for the debts at the same time their income takes a drastic drop.
What should you look out for?
If you’re thinking about signing a personal guarantee, it’s important you approach the decision in a careful and considered way. Here are just a handful of things I strongly advise you think about before you put pen to paper.
Seek advice before signing anything
When you are close to a business, it can be difficult to see the bigger picture. This can lead to directors getting ‘stuck’ on one idea like borrowing with a personal guarantee.
My first recommendation for any business owner thinking about signing a personal guarantee is to seek advice from a suitable professional based outside your organisation. Having fresh eyes look at your situation is invaluable and can often help identify a course of action where you don’t need to provide a personal guarantee.
For example, it might turn out that your business could borrow elsewhere or use another financing strategy like hire purchase or invoice financing. You might even discover that you could delay the spend until later.
Restrict the terms of the personal guarantee
The terms of personal guarantees can vary hugely so it’s important to review what you’re actually being offered and push for any changes that benefit or protect you personally.
There are two main points here that I recommend you focus on: time and scale.
First, try to limit the time the guarantee is active for and have it expire after, say, two, three or four years.
Second, try to restrict guarantee to only a portion of the total borrowing. If your personal guarantee is capped to £1,000, your creditor can only pursue you personally for that £1,000.
Review your personal assets
I know I have said it before but it’s worth repeating. Personal guarantees make you personally liable for a debt. That means your company’s creditor can come after your personal assets.
Before you sign a personal guarantee, take stock of all the personal assets you have. This includes things like your home and other property, personal savings, vehicles and so on.
Unfortunately, it’s all too common for business owners to sign a personal guarantee without actually understanding their own risk or exposure.
Prioritise repayment or refinancing
If you must sign a personal guarantee, consider whether it’s possible for your business to prioritise repayment of the debt.
Alternatively, you can explore the possibility of refinancing the guaranteed borrowing without a personal guarantee. This is unlikely to be an option in the short-term but once you have a few years’ accounts behind you, you should have more options open to you.
What should you do if your company fails?
The harsh reality of life is that many businesses do fail and directors who have signed personal guarantees do become personally liable for debts.
In this section, I’ll highlight a few things to watch out for if you are being pursued for a company debt.
Contact an insolvency practitioner
If you have become liable for a debt via a personal guarantee and are struggling to manage the repayments, it’s incredibly important to seek professional advice from a firm of insolvency practitioners like 180 Advisory Solutions.
Asking an insolvency practitioner to take an impartial look at your situation is invaluable as they can pick through the details of your personal liability and circumstances, assess whether the debt is actually unsustainable and explain your options.
Keep communication lines open with your creditor
Whenever a company fails and a personal guarantee kicks in, you must keep a line of communication open with your creditor.
If you batten down the hatches and stop talking, your creditor is going to panic and assume that you aren’t going to pay. And a worried creditor is much less likely to accept any sort of compromise and is more likely to jump straight to legal action.
So keep answering your phone, keep responding to emails and keep opening letters. Show your creditor that you want to work with them to achieve an outcome that benefits you both.
Negotiate a repayment plan
Your creditor obviously wants to be repaid. However, it’s possible that you cannot handle the original payment schedule set for your business.
If you can't manage the original payment schedule, you should draw up an achievable repayment plan and submit it to your creditor. You may even be able to negotiate a discount if you pay over a shorter period.
Your creditor is under no obligation to accept this plan but it's often in their best interest as it tends to maximise the portion of the debt they recover.
Consider a Debt Arrangement Scheme (DAS)
If your creditor won’t accept your repayment plan, it’s worthwhile investigating what’s called a Debt Arrangement Scheme (DAS). A DAS is essentially a formal agreement to repay your debts over a set period of time. A DAS will also freeze the interest on your debt and block all action against you related to the debt.
Recently, I worked with a group of lawyers who had all signed personal guarantees for loans in an attempt to keep their law firm afloat.
Unfortunately, the firm failed and its creditors began pursuing the lawyers personally. All the lawyers stood to lose their homes as a result of their significant personal guarantees. With these clients, I used a DAS to safeguard their homes while they repaid the debt. You can read the full case study here.
DAS is an immensely powerful debt management tool and is one we have used with countless clients to avoid bankruptcy (sequestration). Even when creditors object to the DAS and refuse to accept it, we can go to Accountant in Bankruptcy and have them ‘overrule’ the objection.
Are you struggling with a personal guarantee?
If you are struggling with a personal guarantee, please get in touch with our team for free initial advice. The longer you give us to work, the better the chance that we can achieve a positive outcome. Click here to talk to a member of our team today.