Overcoming the risks of personal guarantees

EY has predicted bank-to-business lending will contract in 2023 due to reduced demand and rising interest rates. CFOs tasked with raising finance to assist cashflow may look at the alternative finance market for keener rates of interest or release value through invoice finance or asset finance.

Whichever route taken, raising finance in a struggling economy is not an easy task, even for the most experienced CFO and as lenders have become increasingly risk-averse many CFOs are facing a request for a personal guarantee from the business owner, as security for the loan.

It is vital that the finance team fully comprehends the risks of signing a personal guarantee and more importantly, how to mitigate them. It means they can shop from a better choice of loan products and take on new finance with a greater degree of confidence.

What is a personal guarantee?

A personal guarantee gives the lender a written promise, made by a director or number of directors, to accept liability for a company’s debt. 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 they co-own their home, with a spouse or partner – they will also have to sign the guarantee.

In the event that the personal assets are not sufficient to cover the debt, the business owner could face bankruptcy which would have long term ramifications and stop them from being a company director in the future.

Personal guarantees can apply to a wide range of loan facilities including those available from P2P lending platforms – in fact Purbeck sees most of the demand for Personal Guarantee Insurance coming from the alternative finance market.

How to cut the risk

Before deciding that signing a personal guarantee is right or wrong, CFOs should get some independent advice.  An accountant, solicitor or commercial broker can help work out the best options for the business and advise on the additional ways the personal risks can be cut when signing a personal guarantee.  CFOs can also look at how the guarantee could be shared amongst co-directors so that risk it not being shouldered by just one person.

It may be possible to work out with the lender if a time limit can be agreed for the guarantee and a cap on the amount but bear in mind that interest rates are currently rising and costs added to the debt can soon mount up.

It may also be an option to guarantee part of the loan meaning that settlement of the debt is sought first from the company’s assets before enforcing the guarantee.  Clearly in this instance the CFO will need to show what assets within the company could be used – this could be machinery, tools, computer equipment.

Finally, CFO’s could consider personal guarantee insurance to mitigate the risk.  This means if the business does fail, 80% of the loan will be settled by the insurance rather than the business owner’s home, savings and other personal assets being called on to settle the debt.

The level of cover is based on a fixed percentage of the personal guarantee the company director wishes to insure and this will depend on whether the corresponding finance facility is secured or unsecured.  Policyholders are also offered access to free mentoring and support services if the business gets into financial distress, plus expert guidance at the point the debt needs to be settled.

Purbeck’s data shows that applications for personal guarantee insurance more than doubled in 2022 on the previous year with working capital the top reason for new funding.  This huge rise underlines the personal risks many business owners have accepted in the past year to keep their businesses from insolvency.

In Q4 2022, most loans being taken out were between £75,000 and £100,000 in value but looking at the whole of 2022, the biggest year on year increase has been for much smaller loans from £25,000-£50,000 in value, which jumped by 181%.

As businesses face huge cost challenges as they try to recover from the pandemic, where loans are being made available, our experience suggests that the company directors/owners are needing to take on a big chunk of risk themselves and a rapidly growing number are therefore taking steps to protect their personal assets should their business fail.

Business owners are not only facing increasing costs at work, many may feel they are keeping the wolf from the door at home too.  It therefore makes perfect sense that through the wise counsel of their CFO, they use the peace of mind offered by personal guarantee insurance to bring some certainty in very uncertain times.

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