Small business owners should beware when backing their business debt

published 2 October 2019

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.

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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.

David Prosser is a regular Money Week columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments.

David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor. He has won a number of awards, including the Harold Wincott Personal Finance Journalist of the Year, the Headline Money Journalist of the Year and the BIBA Journalist of the Year. He has also been a frequent contributor to broadcast news, providing expert advice and punditry on radio and television.

For the past ten years, David has worked as a freelance journalist, writing for a broad range of newspapers, magazines and online publications. He also writes a regular column for Forbes, and is a frequent contributor to both specialist and consumer publications.