In late 2023, many small business owners in the UK had to sign personal guarantees to keep their businesses running, with 34% seeking loans for daily expenses.
This shows how common personal guarantees are becoming for getting small business loans.
However, business owners need to understand the risks if the business can't repay the loan.
In this article, we'll cover:
What is a personal guarantee?
When business directors borrow money, lenders often request a personal guarantee for security.
A personal guarantee is when someone (usually a Director of a business) promises to pay back money lent by their business if the business can’t. So, if the business can’t pay its debts, the owner or director will have to pay instead. This guarantee gives the lender confidence because they know there’s another way to get their money back if the business can’t pay.
Once a personal agreement is written down and signed, it becomes legally enforceable. There’s no fixed duration for how long a personal guarantee lasts; it depends on what’s agreed upon in the guarantee.
Personal guarantees and director’s guarantees are often terms used interchangeably. They both refer to a commitment by a director to take personal responsibility for a business loan or credit. When a Director is pursued personally, it’s sometimes referred to as “piercing the corporate veil.”
What are some advantages of a personal guarantee?
Personal guarantees are an attractive way of securing finance or credit from a director’s perspective because:
Offering a personal guarantee can significantly boost the chances of securing the arrangement, especially for SMEs;
Getting finance for companies of any size is usually seen as a positive, or even necessary in some circumstances;
They can help companies access much-needed finance that could fuel growth.
What are the risks of a personal guarantee?
The biggest risk of a personal guarantee is if the business doesn’t make enough money, the person who guaranteed the loan could stand to lose quite a lot of money, their home, or personal belongings because they are on the hook if the business can’t pay back the loan.
For this reason, directors need to fully understand that in signing a personal guarantee they’re putting their assets at risk and may need to sell personal belongings or even their home to cover the debt.
What’s more, if the business can’t repay the loan and the guarantor’s personal assets aren’t enough to cover the debt, it may lead to them being declared personally bankrupt, which comes with its share of long-term financial challenges, not to mention that during bankruptcy or a Debt Relief Order, they would not be able to act as a company director.
Some personal guarantees also include an ‘indemnity.’ This means the guarantor agrees to cover any losses the lender faces. Directors usually should avoid agreeing to this if they can.
Are personal guarantees enforceable?
A personal guarantee is usually legally binding and enforceable from the moment it is signed. If the borrower doesn’t pay back the loan, the lender has a right to ask for the money and, if necessary, take legal action to enforce the guarantee.
Generally, a personal guarantee is likely to be enforceable if:
It’s in writing;
It is signed by the guarantor or someone authorised by them;
There was something given in return for the guarantee to be enforceable, like money or a promise.
A personal guarantee might not be enforceable, however, if:
The lender didn’t give the borrower all the information they needed to make an informed decision;
The borrower was tricked or pressured into signing the guarantee;
There’s a clause in the contract that seems unfair.
On this last point, only a court can decide if a clause in a personal guarantee is unfair. If you believe this to be the case, get a free case evaluation from our small business solicitors to see how we can assist you in challenging the guarantee.
For personal agreements, there’s a time limit for taking legal action if there’s a breach of contract. In most cases, this limit is six years from the date of the breach, but for certain types of agreements (like deeds), it can be up to 12 years.
Can a personal guarantee be assigned?
Usually, personal guarantees can’t be easily assigned (i.e. transferred to someone else). If a guarantor wants to get out of a personal guarantee, they’ll need to ask the lender or creditor for permission.
This is usually done through a formal agreement or a document called a Deed of Release. But (and it’s quite a big but) the lender doesn’t have to agree.
Do all lenders require a personal guarantee?
Most lenders will ask for a personal guarantee for business loans. But the amount of assurance they want might vary. For example, one lender might only ask for a guarantee worth 20% of the loan amount. However, others could ask for the full 100%
Whether a loan is secured or unsecured can also affect the amount of personal guarantee a guarantor will need to provide.
Do personal guarantees affect credit score?
A personal guarantee won’t affect your credit score if the borrower keeps making their payments on time.
However, if you have to step in and cover their payments because they can’t, or if the loan defaults and you’re responsible for paying it off, that will show up on your credit report.
If you can’t pay what’s owed, it will hurt your credit score and may affect your chances of getting credit in the future.
Does a personal guarantee need to be witnessed?
Certain lenders may ask that a personal guarantee be witnessed by a solicitor. The solicitor then confirms in writing that the business or director has received independent legal advice and fully understands the implications of signing the personal guarantee.
Is a personal guarantee a good idea?
The recent rise in small business owners and directors taking on a personal guarantee would suggest they aren’t the worst idea. Indeed, a personal guarantee can seem like a good way to secure financing to boost cash flow or expand, especially if other options are limited.
But (isn’t there always a but?) before you commit to becoming a guarantor for a business loan, you should be fully aware of exactly what you’re getting into and the potential risks if the guarantee is enforced, especially to your assets (e.g. your family home or car).
If you are considering a personal guarantee, you should:
Make sure your guarantee isn’t structured as an indemnity. An indemnity involves a commitment to pay additional damages, regardless of the borrower’s obligations.
Find out if your personal guarantee is supported by security, like a charge on your home. This can make it easier for a creditor to enforce if the borrower defaults.
Ensure you understand how creditors will enforce the guarantee, and if they will serve notice or seek payment on demand;
Clarify what is defined as a default under the terms of the guarantee;
Make note of any remedy periods offered;
Consider whether the value of your net assets is likely to change;
It is not possible to say with certainty that a personal guarantee is right for you without knowing the terms of the guarantee and the circumstances around it, such as the financial state of your business both as it stands and in the future.
Does a personal guarantee survive death?
Yes, if a guarantor dies, a personal guarantee won't disappear. Instead, it stays as a potential debt that the guarantor’s estate might have to deal with. The lender may, in some cases, release an estate from this obligation if they find a new guarantor to replace the deceased, otherwise, it remains a potential debt of the guarantor’s estate.
Can I get out of a personal guarantee?
Strictly speaking, no. You can’t get out of a personal guarantee. Even if you die it remains a potential debt on your estate unless a new guarantor can be found. That’s why it’s a very good idea to seek legal advice and understand all of your options before signing on the dotted line!
Having said that, there are some things you can do either before or after singing a person guarantee to protect yourself:
Take out personal guarantee insurance. This insurance protects your assets if the company can’t pay its debts. It covers part of the liability, usually up to 70%.
Negotiate. It is possible to set limits with the lender to restrict your liability upfront. For example, you could try and negotiate a shorter guarantee period or only guarantee a percentage of the debt. This can help limit potential losses and offer peace of mind.
Consider an Individual Voluntary Agreement (IVA): If you’re struggling to repay the debt, an IVA can help spread it over a longer period, and may, even write off some of the debt. However, an IVA can impact your credit score and may require selling equity in your house. Therefore, it’s not always the best option.
File for personal bankruptcy: This should only be considered after you’ve exhausted all of your other options, however, personal bankruptcy can be used to discharge your liability for debts, although it very much should be a last resort, never a first option.
What is personal guarantee insurance?
Personal guarantee insurance (PGI) protects guarantors if the lender calls it in, reducing the risk to their personal wealth. The cost of PGI varies based on the guarantee size and secured assets, but it won’t cover the entire amount.
Possible alternatives to personal guarantees
If you’re on the fence about whether a personal guarantee is the best option for company financing, it’s important to take some time to explore alternative funding options, such as:
Asset finance, which uses valuable balance sheet items in your business as security for a loan;
Equipment leasing and hire purchase for funding new and used assets;
Equity crowdfunding such as donations-based crowdfunding or rewards-based crowdfunding;
Invoice financing is where the lender buys your unpaid invoices and, when customers pay, you get the remaining balance less the lender’s fee;
Merchant cash advances where the lender provides the company with a cash advance that is repaid from a percent of its customers’ debit and credit card payments through a card terminal;
Peer-to-peer lending where people provide money directly to business owners via a P2P platform;
Term loans (also known as unsecured loans or bridge loans) are where the lender and business agree on a fixed amount, interest rate, and timeframe to pay it back.
What happens if you default on a personal guarantee?
If a business can’t pay the debt, then the guarantor of the personal guarantee is held liable. This means you might lose any assets you used as collateral.
Usually, when this happens, the lender will send payment terms, which you should compare to your loan agreement. You’ll need to pay within a set time, or the lender may take legal action or declare you bankrupt.
Get legal advice from Lawhive
Using a personal guarantee can help business owners access finance for growth and cash flow, especially if they lack business assets for security. However, it's important to understand the potential consequences if the business can't repay the debt.
At Lawhive, our expert lawyers are here to help if a lender is enforcing a personal guarantee against you, or to provide guidance on the terms before you sign on the dotted line.
If you’re facing the daunting prospect of a lender demanding payment, our network of solicitors can also take a look at the agreement and assess its validity. If you have grounds for a challenge, they can also help you do that with as little stress as possible.
For more information, get a free case evaluation from our Legal Assessment Team today.