Small business owners should beware when backing their business debt

Hand picking up a house © Gerard Lacz/Shutterstock
If things go wrong, the lender could seize your home

A personal guarantee makes you liable 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 business defaults.

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

There may be other options. For example, the lender may be prepared to accept an indemnity rather than a personal guarantee. This may still leave you liable for your firm’s debt in the event it isn’t repaid, but only in specified circumstances – if there has been some sort of fraud, say. Alternatively, your bank may be able to help you apply for the Enterprise Finance Guarantee (EFG), a UK government-backed scheme.

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.