One of the benefits of setting up your business as a limited company rather than as sole trader is the idea of limited liability. This means that you personally are not liable for any debt that your company gets into, and can’t be pursued for it if the company gets into difficulty or closes.
In theory this seems like a good option for a business which is new and still unsure of the future. However, in practice, many lenders will ask to put a condition onto your borrowing in the form of a director’s or personal guarantee, in order to secure the finance.
What is a personal guarantee?
A personal guarantee is a condition written into a finance agreement which means that, should your company fail to meet all of the conditions and miss payments, you will become personally liable to repay the debt yourself. In essence, you become a guarantor for your business finance, and the contract will state that the director (you) has a secondary liability to fulfil the primary obligations of the borrower (your company).
A personal guarantee is different from an indemnity, which is a primary liability wherein the indemnifier accepts liability for another’s loss, not contingent on the obligations of the borrower. Before making a personal guarantee, you should look over the contract carefully to ensure that you are standing as a guarantor, as this offers you far more security than an indemnity.
Personal guarantees may be secured or unsecured. An unsecured guarantee offers more financial security in the event that debts are accrued, as a secured guarantee is supported by an asset (such as your home) and the lender then has a claim over this in order to pay back your debts.
Who might ask for a director's guarantee?
- Banks and lenders
- Trade suppliers
- Asset leasing companies
- Invoice factoring companies
- Commercial landlords
Questions to ask before committing to a guarantee
- At what point will the guarantee be called in? Will it be after one missed payment or later down the line?
- How is the guarantee likely to be enforced if the business does run into arrears?
- Will there be a notice period?
- What will constitute a default?
- Is there a remedy period? (time allowed for remedying a default without penalty)
- What other avenues will the creditor pursue before making demands on you?
Why might a personal guarantee be called in?
There are lots of different reasons that a creditor might decide to call in your personal guarantee, and this will depend on the terms of the contract, the lender themselves and other factors including:
- If your business looks like it is likely to go bankrupt any time soon. In this case the creditors will want to get in and get as much as they can from you before there isn’t any money there to pay back.
- If your business has been issued a county court judgement
- If the terms of your agreement have not been met. How quickly your guarantee will be called in when terms are not being met entirely depends on the lender or landlord.
What if all directors have given a personal guarantee?
If there is more than one director in your company then you should all have given your personal guarantee when applying for the finance. It is standard practice for all of the directors and stakeholders to give their guarantee to the value of their stake in the company, meaning that you are jointly liable for any debt that the company runs into.
However, there is still the chance that all directors and stakeholders will not stick around when personal guarantees are called in, and in this case the directors that can be contacted will become liable for the full amount of the debt.
Pros and cons of taking a director's guarantee
You don’t have to take a director's guarantee when applying for finance. Your business can be run in any way that you want it to and you must agree everything with all other directors anyway. When trying to decide whether or not to leave yourself personally liable for business debt, it is worth weighing up the pros and cons.
- It makes it easier to get finance. Signing a director’s guarantee can offer you many more lines of credit than you would otherwise be able to find. Lenders tend to feel more secure when there are more ways for them to enforce repayment. You might get better interest rates and repayment terms as well.
- Getting more finance can help businesses to reach their full potential. It is important that companies are comfortable and optimistic about the future of their business and their ability to pay back any borrowing, just as you would personally. But extra finance in the early days can help to boost businesses and push them further, more quickly.
- It could lead to long lasting personal financial problems. The beauty of a limited company is that if it does fail it won’t affect your personal credit rating and ability to get lines of credit in the future. If you tie yourself in with a personal guarantee then there is no such benefit, so you need to have a lot of trust in your business.
- Personal guarantees can be hard to rescind. If you decide that you no longer want any part in the business, it can be very difficult to get a lender to allow you out of the agreement, even if you are no longer part of the business.
How can I protect myself?
You are under no obligation whatsoever to agree to a personal guarantee, but if you do there are a few things that you can look into to make this a safer choice.
- Director’s guarantee insurance. It is not common, nor easy to find, but there is director’s guarantee insurance out there which can help you to make repayments if the debt is passed down to you.
- Talk to your lender. You might be able to negotiate terms with them that make you feel more comfortable in the event that something goes wrong. You may be able to agree on a specific sum that you would need to pay back instead of the full amount owed.
- Look into a debenture instead of personal guarantee. Debenture guarantees give the lender the right to all of the assets of your business in the event that your company can not pay the loan back. All you need to pay out of your own pocket is the shortfall after the lender has liquidated your assets.
Talk to TFMC today
Director’s guarantees are in many ways a necessary evil. They do open up options for your business in terms of accessing varying forms of finance for your business, but with the big downside that you as a director are personally liable for any defaults and cannot hide behind the companies’ shield of limited liability.
TFMC’s helpful advice team can assist you in making this choice so why no call us today to find out about the ways we can help you. Contact us on 0800 470 4820 or email [email protected].