Is a director’s personal guarantee right for your business?

Securing funds to start a business or keep it afloat is a key to business success. Some 20% of businesses fail in their first year and a staggering 60% go bust within their first three years. Having sufficient working capital and money to invest in assets can make the difference between success and failure.

A director’s personal guarantee can get you quick access to investment capital. But what are the risks? We’ll explore them in this article – and look at the loopholes that could protect you if things go wrong.

Signing a personal guarantee
An unsecured liability
Joint and several liability
Terminating a personal guarantee

What does a director’s personal guarantee actually mean?

Business finance generally comes in the form of unsecured or secured loans. Unsecured loans are only made available to companies with a trading history and can be limited. Secured loans normally come with a personal guarantee and allow a business to borrow more, as they are putting up something (very often property) as collateral.

During the Covid-19 pandemic, demand for business loans and financing went through the roof. The government has filled some of these gaps with various schemes and grants, and these (such as the Coronavirus Business Interruption Loan Scheme (CBILS)) do not require personal guarantees unless the sums are over £250,000. But the pandemic also exposed even more directors to the vagaries of the personal guarantee.

To secure loans, financial arrangements, and even leases, directors will often be asked to sign personal guarantees with banks and other lenders, perhaps without always understanding the full implications. This is especially true of companies with a limited (or poor) credit history.

However, signing a director’s personal guarantee as assurance for business credit can feel like the only option available. The pressure of getting the finance in place can mean that the wider company and personal implications of signing a personal guarantee are often not given the attention they demand.

When lending money banks typically require a personal guarantee (sometimes called a director’s guarantee) from one or more directors, which means they agree to repay the loan if the company cannot. This in effect mitigates the lender’s risk and provides them with another avenue to recover their money.

Put simply, if you sign a director’s personal guarantee on behalf of a business when taking out a loan you are legally agreeing to become personally responsible for the financial obligations of the business to the lender, and in the event that the business fails to make its loan repayments.

Companies such as iwoca, Funding Circle and many others rely on a personal guarantee to secure their debt. Others such as Nationwide Corporate Finance rely on a charge on a residential property.

In an industry standard practice, building trade suppliers also include personal guarantees within credit application forms and have been doing so for many years.

For practical advice on adapting your business and safe-guarding your future, call 01455 555444 to speak to one of our licensed insolvency practitioners, email us at [email protected] or request a call back

An unsecured liability

A director’s personal guarantee, however, is not a secured liability – it is unsecured. That means the debt remains unsecure, unless it has been secured with a debenture (on a company asset) via a floating charge, or a fixed second charge on a personal asset such as the family home.

It’s possible to insure against the director’s personal guarantee, which can minimise the risk against you personally should the worst happen (a quick search of the internet will generate the names of dozens of brokers who provide this type of insurance).

Any loan signed with a personal guarantee by a director is likely to have a clause that allows the lender to recall the money at any time. This is known as the ‘insolvency clause’, adding another layer of security for the lender, and means even in cases of insolvency the debt is still recoverable.

A company going into administration would not protect you from the obligations of a director’s personal guarantee. If this happens then you can expect the lender to immediately issue a demand for a repayment of all the outstanding monies. This will come in the form of a statutory demand letter, and on top of requesting the full amount there will be interest and other charges to pay.

Joint and several liability

When all the directors in the company have signed a guarantee, the liability is shared and is called a joint and several liability. That means until the debt is paid off the liability remains, regardless of whether it is paid by one or more of the directors.

So, if one director pays off the debt, then it’s up to all the directors to sort out between who is liable to pay what to whom!

It also means the creditor can choose to sue all the directors or just one. If more than one director has provided a personal guarantee for a loan the lender will generally target the director who is most financially able to pay or owns the highest value assets.

Director’s personal guarantees are, however, sometimes capped so your liability may only cover part of the loan, or there may even be a time limit on your liability.

Terminating a director’s personal guarantee

If you sign a personal guarantee and then resign as a director, your resignation does not automatically terminate the personal guarantee, and you will still be liable.

You have to do the terminating – even if there is an undertaking by your company or your company’s purchasers to terminate the personal guarantee, because they cannot do this on your behalf.

Personal guarantees are viewed as some of the most legally binding contracts in common usage.

Lawyers could have some avenues to challenge a creditor’s right to your home. Key areas of contention are:

Deviation from the original terms, such as the creditor increasing the loan amount.
Negligent behaviour on behalf of the lender.
A change in the principal loan amount without informing the guarantor.

It’s important that you go into a personal guarantee arrangement with your eyes open. Business loans can provide much-needed funds when you need them, but can also leave the family home on the line if things go wrong.

While an unsecured loan might be the way you want to go, many lenders are very risk-averse and that means they will be steered to a secured loan and a director’s personal guarantee. If you’re unsure how to act – and think you need to borrow money to keep your business afloat – we could help you find another solution.