Small-business owners and directors face a potential timebomb following the pandemic. New research suggests that hundreds of thousands have put personal assets, including their homes, at risk. Last year, more than a third of small businesses took out loans with personal guarantees attached, according to Purbeck Insurance.
Small businesses typically manage their finances, including borrowing, separately from the personal affairs of their owners and directors. This protects owners if the business fails because lenders cannot come after them personally for outstanding debts.
However, where lenders are nervous about the risk of lending to businesses, they may demand a personal guarantee from directors or owners. The guarantor is then legally responsible for settling the debt if the business cannot meet the repayments. Lenders can pursue guarantors for unpaid loans, demanding they sell personal assets, including a family home, in order to pay what is owed.
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Under the terms of state-backed Covid-19 initiatives such as the Coronavirus Business Interruption Loan Scheme (CBILS), lenders were typically banned from demanding personal guarantees. But this did not apply on the largest such loans, or on loans arranged outside of these schemes. In Purbeck’s survey, 24% of small firms said they had arranged non-government backed loans that came with personal guarantees, while a further 10% took out CBILS loans large enough for lenders to be entitled to demand such security.
Personal guarantees can make sense in certain circumstances. If your company is short on assets – a problem for many service-sector companies, for example – it may struggle to raise finance even if it is trading well. A personal guarantee, if you are confident that it will never be called upon, can then be a way to raise finance for growth purposes, and to do so at an affordable interest rate.
How to mitigate risk
However, it is vital to enter into personal guarantee arrangements with your eyes open, ideally taking legal and financial advice. There are traps that can catch out the unwary and steps you can take to mitigate risk. Check the terms of guarantees carefully. In some cases, lenders can demand immediate repayment, often with no flexibility to negotiate repayment terms. You may also be on the line for the bank’s costs, including if you decide to pay the loan early. And where several directors provide personal guarantees “jointly and severally”, the bank may not have to chase all of them; it can demand the whole amount from a single director.
There may be some room to push for better terms to protect yourself. Lenders may be prepared to exempt certain assets from the guarantee – the family home, say – if there are other assets of sufficient value to provide security. Alternatively, non-recourse loans, where lenders have no claim beyond certain assets, even if these are not sufficient to repay the debt, can provide some reassurance.
If you are not the sole owner of the business, you may look for additional protections when arranging personal guarantees. For example, you may want to agree a list of issues on which the business cannot make decisions without your consent. You may want provisions that require the company to settle the loan once it has sufficient funds, before it makes other commitments. You should also understand your position if you were to leave the company – or get fired.
Finally, personal-guarantee insurance, available from a small but growing number of specialist insurers, is also worth considering. This covers some of the cost of repaying the loan if the business cannot manage it – up to 80% with certain policies. That reduces the liability of the guarantor. Insurance can be taken out for existing personal guarantees as well as new ones, which may provide some protection to those who borrowed last year.
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