Interest rate hikes have curbed cheap lending options but as businesses seek a path through continuing economic uncertainty, there is often another barrier in their path – a personal guarantee demand as security for a business loan.
So what is a personal guarantee? A personal guarantee is a written pledge made by a director or number of directors, to accept liability for a company's debt should the business fail. A request for a personal guarantee is not surprisingly a big gulp moment for many business owners and directors and the source of a great deal of anxiety and lost sleep.
Of course no-one starts a business expecting it to fail but we can't ignore the fact that insolvencies have been rising to levels not seen prior to the pandemic.
The number of registered company insolvencies in June 2023 was 27% higher than in June 2022. This is higher than levels seen while the Government support measures were in place in response to the pandemic and also higher than pre-pandemic numbers1.
This really underlines the challenges of running a business in the current environment. Many of the financial issues businesses are facing are pretty much outside of their control – rising energy costs, late payment, interest rate rises on existing loans to name a few. The vast majority of loans we support are for working capital to keep the business going.
The fact is that when a personal guarantee is in place, if the business defaults on a loan, the director's home, car and anything in their personal bank account could be used to settle the outstanding debt. If the home is co-owned – the co-owner will also have to sign the guarantee.
Considering that 10% of the loans we support are for £175k- £200k, the current average personal guarantee backed loan through the Recovery Loan Scheme is £472k, and the average house value was £286k in May2, there might even be the possibility that the personal assets aren't sufficient to cover the debt. In this case, the business owner could find themselves facing bankruptcy which would have long-term emotional and financial ramifications and stop them from being a company director in the future.
Signing a personal guarantee is a major decision that increasing numbers of business founders now face. We're seeing this trend in the volume of applications for Personal Guarantee Insurance from businesses which were up 78% in June 2023 on June 2022.
Now for good news. While it can seem daunting, the risk of signing a personal guarantee can be mitigated in a number of ways.
Firstly it is vital to seek independent, expert advice from a solicitor or accountant. Our research has shown that accountants are the small business's number one ally when it comes to financial support.
If the business has a number of co-directors it would make sense to share the guarantee amongst this group.
It is also possible to explore with the lender if a time limit can be agreed for the guarantee and if a cap can be set on the amount. Bear in mind though, that interest rates are rising and costs added to the debt can soon mount up.
Asking whether a lender would agree to part of the loan rather than the whole loan being guaranteed is also a possibility and if successful, another helpful way of mitigating any potential personal losses. This would mean that settlement of the debt is sought first from the company's assets before enforcing the guarantee. Clearly, in this instance the business owner would need to show what assets within the company could be used – for example machinery, tools, or computer equipment.
Finally consider Personal Guarantee Insurance (PGI). With this relatively new type of insurance in place, if the business does fail, 80% of the loan would be settled by the insurance rather than the business owner's home, savings and other personal assets being called on to settle the debt. There would also be mentoring advice and support at the point the debt needs to be settled, taking a big burden off the shoulders of the business owner at what can be a very stressful time.
Running a business can be hugely rewarding but also incredibly tough – and it is perhaps tougher now than it has been for some time. Business owners need to be realistic about the financial risks and go into ventures knowing exactly what they can do to limit them.
Todd Davison, MD, Purbeck Personal Guarantee Insurance
https://www.gov.uk/government/statistics/monthly-insolvency-statistics-june-2023/commentary-monthly-insolvency-statistics-june-2023
https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/may2023