What you need to know about loan guarantees.

By January 27, 2017 No Comments

Would you really be surprised if I were to tell you that 55% of SME business owners do not know what a personal guarantee is?

Research released by Wirefund, an SME loan provider has produced results that some might find shocking. How often do we hear the phrase ‘read the small print’ before we sign a legally binding document?

How many of us ever actually do anything other than skim the small font either because our glasses aren’t close to hand, or we just assume that we know better and don’t need to waste our time on the small print, assuming naively it’ll be OK?

These could be agreements where a signature is required for confidentiality purposes, or a credit agreement that covers your lovely new sofa. As an SME, you may be needing to sign a personal guarantee for any number of reasons because you need a loan. You could be expanding so quickly and have outgrown your existing premises. Your long term gain could be to apply for larger-scale financing for your business, the case can be made for starting with a smaller, short-term loan in order to build your business credit.

It’s likely that you’ll need to consider purchasing the latest IT equipment, machinery or other tools to make your product or perform your service or you could have found a business opportunity that outweighs the potential debt. For any of these scenarios, you’ll be considering a loan, or loan guarantees for business finance.  More worryingly, this could be a signature that covers what you’re liable for if you fail to meet the terms of the loan guarantee.

Wikipedia states: A loan guarantee, in finance, is a promise by one party (the guarantor) to assume the debt obligation of a borrower if that borrower defaults. A guarantee can be limited or unlimited, making the guarantor liable for only a portion or all of the debt.

In principle this reads as relatively straightforward. As a business, you borrow some money, agree to pay it back, and sign up to the liability of the debt. However banks aren’t stupid, they won’t lend money unless they believe they are going to get it back, and this is where the personal guarantee comes into play. A personal guarantee is viewed as an “added assurance” that the owner or executive is committed to the business and to repaying the equipment lease or loan. A personal guarantee demonstrates to a lessor or lender that you are a responsible business owner and intend to repay all of your business leases and or loans.

Without it many small businesses simply can’t get loans. But do you really understand what you’re signing up to? It might be worth considering the following …

  • Are you aware that you are liable for paying the entire debt on time, not just when you deem you can afford it? A tough month on sales is unlikely to cut the mustard with your lender. You agreed the repayment terms
  • A personal guarantee is likely to state that you are personally liable for the lease or loan obligations of your business and may also declare that you are liable for default interest, legal and other fees. In the event you sell your interest in a business, unless you are properly released from the personal guarantee, you will still be held liable if the lease or loan goes into default. You may be required to pay off the lease as part of the sale of the business
  • Don’t sign a personal guarantee unless you are fully aware of the Company’s plans and finances. If in any doubt always consult a lawyer
  • When you provide a personal guarantee, you allow a lender to pursue you personally if you can’t repay a business loan which could have implications in terms of your family such as losing the family home. Some loans may also require your spouse’s guarantee so assets held solely in your spouse’s name are fair game as well (otherwise, you might be tempted to transfer assets to your spouse’s name).
  • Look out for the term ‘joint and several’. This allows the bank to try to collect the entire balance from any and/or all partners who personally guaranteed business loans. If other partners can’t pay, the bank may demand the entire balance from you. Even if you aren’t a 100% owner, you might be 100% responsible for the debt.

Many SME’s are unable to grow without financial help from an outside source. The long and the short of taking out a loan of any kind from a bank, is that the banks will want to be able to collect the debt no matter what happens to your business. They are unlikely to consider taking a risk on you, if you are not prepared to stick your own neck on the line, showing you have faith in your own business by signing a personal guarantee.

Do yourself a favour….when it comes to signing a personal guarantee…ALWAYS read the small print.