Taking out a loan for your business can be a challenge, and there are often strings attached that business owners don’t fully understand. There is significant importance attached to understanding conditions attached to business loans, such as personal guarantees, and understanding exactly what they mean prior to taking out a loan is often overlooked.
Taking out a business loan without fully understanding the consequences attached to them is something that frequently happens in the business world. Therefore, as a business owner, you should ensure that you fully understand any consequences attached to a potential business loan.
What is a personal guarantee on a business loan?
Business owners often have the benefit of being considered as separate entities to their businesses and while this can be advantageous, it puts them at a disadvantage as far as acquiring loans is concerned. A personal guarantee, on the other hand, is a legal agreement where the director or owner of the business agrees to be liable for paying any debt accrued by their company, should they be unable to pay it from the company’s accounts.
The director is known as the guarantor and is responsible for paying any debts out of their own worth, should the company go under. Additional security in the form of assets, such as property or a vehicle, is not necessary where a personal guarantee is concerned, and this guarantee can consequently be provided by more than one person if necessary.
From a lender’s point of view, the loan is much more secure with a personal guarantee attached to it because of the fact that responsibility for the loan would fall on the guarantor(s) should the company itself default on repayments.
Lenders need security on their loan – they need to have that guarantee that should the worst case scenario happen, and the company falls into a state of liquidation that they are not left out of pocket. Such a process demonstrates responsibility and that you intend on paying back your loan.
Personal guarantees are generally required to support most business borrowing applications where the owners find themselves benefiting from limited liabilities- such is the case with limited companies and LLPs. Where this is the case, it is possible to protect yourself from liability with Personal Guarantee Insurance – in the event that the personal guarantee is called on by the lender, for whatever reason, the insurance policy will cover the costs to give you that much-needed financial relief although this will not come without a fee.
If you sell your business, then you need to make sure that you have your lenders release you from the personal guarantee. If you are not fully released from this agreement then you are still liable for any default payments on the loan should the new owner fail to make payments. As part of the sale of the business, you may find that you are asked to pay off the sum of the loan.
What are the pros of a personal guarantee?
Personal guarantees on business loans allow companies the opportunity to acquire financing routes, irrespective of their credit rating. Taking out a loan allows the business the opportunity to grow and reach additional clients – something that they might not be able to do without additional funding.
It is possible to negotiate with your personal guarantee. For example, you can spread the risk proportionately between all of the investors. This way, each of the investors only has to pay a percentage of the debt, should anything go wrong with the business.
What are the cons of a personal guarantee?
Positives aside, there are consequences if the business loan is not paid or your company goes into liquidation. If this were to happen and the financial obligations of the business were unable to be met, as guarantor by means of this personal guarantee, you would be responsible for paying off these debts, putting yourself at risk of financial difficulty.
It’s fair to say that by making this guarantee, you believe that you will never be in a position where you need to take on the debts of your business. It’s important for anyone who is considering applying a personal guarantee.
Before agreeing to sign a personal agreement on a loan, you should carefully consider the stakes involved in doing so. Consider whether you could afford to pay off the loan on behalf of your company if the worst was to happen. You should also consider if there are other options available that may well be more suited to the needs of the company and doesn’t require you to sign over your personal livelihood.