Nobody ever said running your own business was easy: you have customers and staff and bills to deal with, and on top of that you’ll need to borrow from time to time to power growth or tame a troublesome cash flow. Carl Faulds, of Cashsolv Business Loans, takes a closer look at the business of business loans.
So it may appear that the more business partners you have, and the more you can spread the workload, the better. However, this isn’t always the case – particularly when you’re looking to borrow.
What is a personal guarantee?
As its name suggests, a personal guarantee for a business loan is your commitment that should the company fail to repay, then you will do so out of your own money and personal assets. By giving such a guarantee, you significantly lower the lender’s risk, as they can seize your personal assets or sue you as an individual should things go wrong. For this reason, banks sometimes insist on a personal guarantee for loans to new businesses or those with a chequered history.
Of course, many company owners are reluctant to sign such guarantees, as this can put their personal assets – potentially including the family home – on the line should the business fail. The situation is particularly complicated if the company has a number of owners, as the bank may require personal guarantees from any or all of them. What’s more, some company owners may have such low personal credit scores that a personal guarantee from them is effectively worthless.
Why do banks require personal guarantees?
The simple answer is risk: lots of young companies go under and even relatively established and fast-growing small businesses can fail. (In fact, a period of rapid growth can be particularly risky for a company, as it places additional strain on the cash flow.) As a result, the reassurance that the bank can pursue you for your personal assets should things go wrong may make the difference between acceptance and refusal.
Why do things get complicated when there are multiple partners?
If a personal guarantee applies to more than one individual, then more than one credit score needs to be taken into account. For example, you could have a strong credit score of more than 700 whilst your business partner, who owns more than a third of the company, is languishing on a mediocre 500. In this instance, your loan application may be refused, even though the business is going great guns and even though your own credit score is impeccable.
Finally, a word of warning
Whilst any personal guarantee is inherently risky – you can lose everything, up to and including your home – there are two different types of guarantee. If you’re a sole trader, you’ll be signing an unlimited guarantee, meaning your lender can pursue anything you own to cover the entirety of the debt.
If you have business partners, a several guarantee means that you are only liable for the portion of the debt that corresponds with your ownership of the business (so if you own 30%, you can only be pursued for 30% of the debt). With a joint and several guarantee, which is much more common, the lender can pursue any and all partners for the entire debt, meaning that they will target the partner with the most assets.
Be extremely careful what you sign, and always be aware that alternative lenders may offer finance without a personal guarantee where banks will not. By looking at the entire finance market, and focusing on lenders who do not demand personal guarantees, you could save yourself from a great deal of heartache – and potentially even homelessness – in the future.
Carl Faulds is the , managing director of Cashsolv Business Loans