Understanding business loans and personal guarantees

Business loans typically play a significant part in a company’s development, but to secure business borrowing directors are often asked to provide a personal guarantee. It helps to protect lenders who might not be willing to sanction a loan without this reassurance.

Directors, however, may be unaware of the potentially serious ramifications of providing personal guarantees, instead focusing on the fact that without one they would fail to secure borrowing and would need to consider alternative arrangements.

So what happens when a company cannot meet the contractual terms of its business loan, and also when a director has provided a personal guarantee?

Securing the right terms for business lending

Before signing up for a business loan it’s important for directors to check the terms and conditions so they fully understand what would happen if a payment is missed, and at what stage it’s regarded as a default.

If a personal guarantee is required they should also be aware of the implications for their personal finances in the worst-case scenario.

What exactly is a personal guarantee?

A personal guarantee provided by a company director makes them liable for the amount outstanding should the company be unable to meet the contractual terms of a business loan.

Lenders can pursue the director(s) through the courts, in some cases seizing personal assets including their home if the individual cannot afford to clear the debt. Personal guarantees are often demanded by lenders to reduce their risk, but are also a sign that directors have sufficient confidence in the business to place their personal funds at risk.

Guarantees can vary in terms of the level of personal liability taken on, and may be capped at a pre-agreed amount. Additionally, not all personal guarantees put a director’s home at risk – some are based on an individual’s overall net worth and take into account their personal credit record.

Defaulting on a business loan

If the company cannot repay a secured loan, the lender repossesses the asset on which it’s secured. With unsecured business loans the outstanding amount is demanded back, and the underlying threat of a creditor winding up petition emerges.

Lenders often have an alternative option, however, in the form of a personal guarantee if one has been provided when the loan was taken out. This means they can pursue the individual through the courts, and ultimately petition for a bankruptcy order should the director be unable to generate sufficient equity in their home or sell it to repay the debt.

Understanding personal guarantees

Directors may not believe a personal guarantee will be called upon, particularly if the company is developing and strong sales and profits indicate only growth ahead. It only takes the loss of a large customer, an unexpected bad debt, or a downturn in the market, however, for businesses to decline, leaving the scenario that once seemed highly unlikely suddenly a distinct possibility.

Another consideration is that if more than one director has provided a personal guarantee for a business loan, the liability isn’t necessarily spread equally between them. Lenders will initially seek repayment from the director with the highest net worth/value of assets.

It may be possible to limit a director’s liability by offering alternative forms of security, but whatever the situation, professional guidance is essential to ensure the business loan meets the needs of both the company and its directors.

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