Personal guarantees and business loans: everything you need to know
In this guide, we detail exactly what a personal guarantee is, how they work, how long they typically last, if all lenders normally ask borrowers to provide one, their advantages and disadvantages, when businesses will likely need one, and much more.
Personal guarantees are customary practice in corporate financing as they give lenders added security and extra peace of mind that they can recuperate the money they loan out to businesses. In simple terms, a personal guarantee is a legal contract made between a guarantor and a lender. When a personal guarantee is signed, the guarantor and the lender contractually agree that if the business borrowing the money cannot repay it, the individual who signs the contract is responsible for any outstanding debt. This gives lenders an added layer of security when providing debt finance.
‘Director’s guarantee’ and ‘personal guarantee’ are both terms used in the industry interchangeably. They essentially mean the same thing, so when a lender requests a personal guarantee, they are typically referring to a personal guarantee made by a director at the company borrowing the funds.
The reason lenders request a director to sign a personal guarantee, rather than someone else outside of the business, is because it shows that the director is confident that their business will be able to keep up with the repayments and is on a path to success or growth. As such, they’ve put their own money down as a security net with the belief that they won’t ever need to use it.
When a business owner signs a personal guarantee on a business loan, that person is responsible for paying off all or part of the business’ debts if the business is unable to. Personal guarantees are usually unsecured, meaning they aren’t tied to a specific personal asset such as a house. This means the business owner is simply required to pay the loan back using a liquid asset such as cash.
Yes, a lender may request more than one director’s guarantee on the business loan, especially if the loan amount is high and the loan is not secured against any tangible assets. If there is more than more personal guarantee it’s classified as a joint and several person guarantee. Joint and several guarantees mean that the group, as well as each individual, is responsible for paying off any outstanding debt.
For example, if there was outstanding debt of £4,000,000 that could not be repaid by the business, it would fall to the group of personal guarantees to pay it off. If there are four directors as guarantors, they could each pay off £1,000,000 – but if one director didn’t pay, the remaining guarantees would need to pay off the full amount regardless.
When looking at personal guarantees for business loans, these will last as long as is stated in the contract signed by both the guarantor and the lender. However, it is important to know that the guarantee may also become unenforceable after a limitation period, after which the creditor won’t be able to claim. Every personal guarantee will be unique to each transaction, so it’s essential that all terms and conditions are fully understood by the guarantor before anything is signed.
Most lenders will typically require a personal guarantee when taking out a business loan. However, the level of assurance won’t always be the same as the loan amount. For example, with some types of borrowing, the personal guarantee will be as little as 20% of the loan amount, with other lenders asking for up to 100%. Personal guarantees will also differ depending on whether you take out a secured or unsecured loan.
Since personal guarantees don’t typically require any fixed assets, such as a house, businesses don’t necessarily need to have any collateral to secure a personal guarantee on a loan. However, businesses typically need to have some funds to show that they’ll be able to pay off the loan, as lenders will look to analyse the guarantor’s assets and liabilities to ensure that they can meet the obligation of the personal guarantee.
Lenders may ask the borrower to act as a guarantor or as an indemnifier. Here’s how the two differ:
Personal guarantee: As mentioned, a personal guarantee is a promise made between the guarantor and the lender, meaning that the guarantor is promising to repay the loan should their business ever be unable to make the agreed repayments.
Indemnity: According to In Brief, an indemnity is a promise to be responsible for another person’s loss, and to compensate them for that loss. If, for example, you enter a contract with a travel agent to book a holiday which includes hotel accommodation, there may be an indemnity to the effect that you will be responsible for any loss caused to the hotel by any damage you have caused, and to adequately compensate them for their losses. When notified of the loss suffered, the indemnifier must compensate the indemnified as agreed.
In the case of debt finance you can have separate guarantees and indemnifiers, or one person acting as both. It’s important to fully understand what you will be acting as before signing a contract, as the outcomes in a loss event will be different.
When a borrower agrees to a personal guarantee, they’re offering more security to the lender and as a result, this could be the incentive the lender needs to agree on the transaction.
Borrowers that can offer up more security can usually get higher loan amounts over a longer term.
In some instances, a personal guarantee might be the key to unlocking access to finance for a business. For example, the guarantee may lead to a growth business achieving its potential in the medium to long term.
Because personal guarantees are not tied to a specific piece of collateral, they offer added flexibility when compared to a secured loan, since the borrower doesn’t have to put any specific assets on the line.
If the borrower’s business becomes insolvent, it will be the responsibility of the guarantor/s to step up and make the repayments themselves. And if the borrower is not able to comfortably make the repayments, it could lead to financial problems such as bankruptcy.
Even if a borrower’s business is performing well currently, things may not work out in the future. This means that the personal guarantor would be responsible for any outstanding debt, personally.
Some of the most common scenarios where a lender may request a personal guarantee include:
Signing a personal guarantee on behalf of a business will not affect the guarantor’s credit if the loan is paid back in full on time. If, however, the business falls behind on repayments or goes into arrears this is likely to affect the director’s personal credit score. If the business does not repay the debt, the director that signed the personal guarantee will be forced to pay off the rest of the balance themselves. This could affect them negatively and in some severe cases cause them bankruptcy.
Although providing a personal guarantee on a business loan will typically increase your business’ chances of being accepted for a loan, and could secure better interest rates, they do also come with personal risk. If a business is unable to repay the agreed loan, the guarantor will need to step in, which may compromise personal savings or even result in personal bankruptcy, which will show up on their credit report.
Therefore, it’s critical that businesses consider all their options carefully before signing up for a personal guarantee. If business owners are unsure about anything in their contract with the lender, it would be beneficial to seek independent legal advice before signing a personal guarantee for a business loan.
At OakNorth, we offer fast, flexible debt finance – including both secured and unsecured loans – where we may request either a personal or corporate guarantee e.g. a guarantee from another entity in lieu of a personal guarantee.
With this in mind, before you consider a long-term loan with us, you should have a well-structured business plan, strong financials, a profitable business, and the right experience and expertise to scale in your sector.
If an opportunity appears that will add value to your business, help you accelerate your profits, build out your business in new areas, differentiate you from competitors, and allow you to thrive in an extremely competitive market, then we want to hear from you.
Not only could we finance the next stage of your journey, but our team of experts can help you navigate the loan process, achieve the best outcomes, and ask all the right questions to turn your aspirations into achievements.