Small business owners should beware when backing their business debt

A personal guarantee makes you liable for your firm’s debt. Tread very carefully.

Hand picking up a house © Gerard Lacz/Shutterstock

If things go wrong, the lender could seize your home

A personal guarantee makes youliable for your firm's borrowings.Tread very carefully.

Would you face serious personal financial hardship if your business went bust? Many entrepreneurs assume not. After all, one argument for setting up a business as a limited company, rather than operating as a sole trader, is that you separate your affairs from the company's.

However, while this is true in theory, it may not pan out in practice. If your business needs to borrow, lenders often expect owners to stand behind the loan. They ask for a personal guarantee that the debt will be repaid. These guarantees aren't secured they're not tied to a particular asset, such as your home but they do give lenders a legal right to come after your personal wealth in the event your businessdefaults.

Personal guarantees are a common feature of loans to small and medium-sized enterprises (SMEs). Just over 30% of such businesses were required to sign a personal guarantee as a condition of their most recent financing deal, according to Purbeck Insurance Services. And 39% of business owners didn't realise their personal assets were at risk if they signed such a guarantee. Lenders say that personal guarantees enable them to offer loans to businesses that lack security of their own or appear risky, perhaps because they don't have lengthy trading histories. And some business owners will feel confident about signing a guarantee.

But it is crucial you understand the implications, preferably having taken legal advice. If things go wrong, the lender may seize your assets your savings or even your home; and it could ultimately force you into personal insolvency.

Explore the alternatives

Aimed at SMEs seeking to borrow up to £1m but lacking the security that lenders require, the EFG promises the lender that the government will act as a guarantor for 75% of the value of the debt. There are additional fees to pay, but 30,000 businesses have used the scheme in the past decade.

Another option is to seek out alternative finance the industry has grown rapidly in recent years, with invoice finance and peer-to-peer lending helping to fill the gap created as banks have become more risk averse. These forms of finance don't typically require personal guarantees.

Recommended

Dividend payout advantages drain away for small-business owners
Small business

Dividend payout advantages drain away for small-business owners

Life is getting harder for sole traders who opt for dividend payouts rather than taking a salary from their business.
17 Sep 2021
Cybersecurity is crucial for small businesses
Small business

Cybersecurity is crucial for small businesses

Small companies tend to neglect the defence of their digital data, but the risks are very high, says David Prosser.
6 Sep 2021
Time for small businesses to pay back emergency state aid
Small business

Time for small businesses to pay back emergency state aid

Small companies struggling to repay emergency loans have several options, says David Prosser.
21 Aug 2021
Government launches final Covid support scheme for the self-employed
Small business

Government launches final Covid support scheme for the self-employed

A fifth and final round of the government’s aid scheme for the self-employed, with grants of up to £7,500, has been launched.
6 Aug 2021

Most Popular

The times may be changing, but don’t change how you invest
Small cap stocks

The times may be changing, but don’t change how you invest

We are living in strange times. But the basics of investing remain the same: buy fairly-priced stocks that can provide an income. And there are few be…
13 Sep 2021
Two shipping funds to buy for steady income
Investment trusts

Two shipping funds to buy for steady income

Returns from owning ships are volatile, but these two investment trusts are trying to make the sector less risky.
7 Sep 2021
How to stop recurring subscriptions becoming a drain on your money
Personal finance

How to stop recurring subscriptions becoming a drain on your money

Tracking and pruning subscriptions isn’t as easy as it sounds. Here's how to take charge.
14 Sep 2021