Loans and personal guarantees – what company directors need to know
As a company director, you may be required to take out an unsecured business loan with a personal guarantee agreement in place to raise capital, purchase stock and pay suppliers. In order to qualify for unsecured commercial finance, the lender will take a close look at your spending behaviour to understand your attitude to lending. Analysing spending history allows the lender to understand if you are responsible with finance repayments.
A personal guarantee allows the bank to secure protection against non-payment. A private lender may also require a personal guarantee in order to exercise control over the director’s assets in the event of non-payment.
What is a personal guarantee?
A personal guarantee is a written agreement which guarantees repayment for a loan or finance facility. In the event of non-payment, the lender is able to take control of personal assets. If you fail to repay the loan or an invoice facility, you will be held personally liable for the costs if you have signed a personal guarantee.
A personal guarantee is typically agreed to by the director if they have confidence in the business, allowing them to take on the personal risk. Personal guarantee is a form of reassurance for the bank which could allow you to borrow a higher loan with more flexible payment terms.
Advantages of a personal guarantee
A personal guarantee on a loan can widen the variety of loans available to your business, including better terms and repayment instalments.
- Limited guarantee: Liabilities can be capped at a percentage, limiting personal risk
- Eligibility: Greater chance at eligibility for cheaper loans if a personal guarantee is signed
- Business recovery: Extra finance can help the prospect of recovery for the business
- Co-guarantor: Depending on the business and finance facility, you may require a business partner or family member to co-sign the personal guarantee, dividing the risk.
If you are confident that your business is well performing and profitable, you may be open to personal risk which is attached to a personal guarantee.
Disadvantages of a personal guarantee
- Personal risk: Non-payment could result in the seizure of personal assets, including property and personal funds.
- Bankruptcy and insolvency: If you are unable to repay the loan, interest and fees, you risk the seizure of personal assets and funds which could lead to bankruptcy and corporate insolvency.
- Unlimited guarantee: Liabilities can be unlimited which means that the bank can use powers to recover the entire cost, interest and legal fees.
Alternative forms of finance for company directors include invoice finance which are asset backed lending products, such as invoice factoring and invoice discounting, both of which involve exchanging an invoice for immediate payment. This is commonly used by businesses to inject capital into the business and this form of finance typically involves signing a personal guarantee agreement.
What is invoice factoring?
This form of funding will provide advances on cash due from customers, allowing earlier access to a certain percentage of funds. Once the invoice has been raised, the funder will make payment which amounts to a majority portion of the total amount. Once the customer makes payment, the remaining funds will be paid to the company by the lender, minus fees and charges.
This makes cash flow management easier as there will be no outstanding funds as invoice factoring unlocks funds tied up in unpaid invoices. Some factoring companies may include credit control which saves you time chasing the unpaid invoice.
What is invoice discounting?
Once the invoice has been raised, the lender will transfer the agreed balance to your company. Once the customer makes payment, you will retain the agreed amount and transfer the remaining funds to the provider, including fees and charges.
In comparison to invoice factoring, you will have more control over the collection of the debt from the customer. This form of finance is typically used as working capital to purchase stock and fulfil the customer order.
Considerations for a personal guarantee
A personal guarantee on a business bank loan can give access to funds to invest into your business. Signing a personal guarantee for a loan can have a higher level of risk but there are key considerations which should be taken prior to signing the agreement.
- Is the payment on demand or will you be given notice?
- How will the action be enforced?
- Will you be given a period of time to resolve the issue before action is taken?
A personal guarantee should not be taken lightly as this poses a high risk to personal assets which will be unprotected following acceptance of the agreement. Personal guarantee insurance can be taken out as a form of protection for small to medium enterprises taking out a loan with a personal guarantee.
If this article resonates with you as you are currently considering a personal guarantee agreement, a licensed insolvency practitioner can provide advice by arranging a free no-obligation consultation. Get in touch with a member of the Handpicked Accountants team to find out more.