Almost all businesses have to borrow money from time to time, sometimes in the form of a debt consolidation loan, and gaining access to credit often means an executive or partner in the company must offer a personal guarantee.
A personal guarantee is a promise made by that individual to pay back the credit being offered – if the business is unable to pay a loan back then the personal guarantor becomes individually liable for the debt. A lender will often ask for a personal guarantee if they want extra reassurance that they will actually get their money back.
How a personal guarantee works in practice
A personal guarantee is often needed when a new or relatively small business needs to borrow money to fund their operations. This is because the business will not have had sufficient time to create the kind of credit history needed to source loans without recourse to a personal guarantee.
When making a personal guarantee the principals of the business are making a legal promise that if the business defaults on the loan repayments they will use their own assets or personal capital to make up the shortfall and ensure that the debt is cleared. When the credit agreement is signed, in other words, the owners, partners or executives co-signing alongside the business itself.
Why lenders might ask for a personal guarantee
Lenders will be aware that a business is too new to have built a strong credit rating, or even that the business has actually got a poor credit rating. In such cases they will seek the extra insurance offered by a personal guarantee based on the credit history of the individuals concerned. Anyone offering a personal guarantee must be happy for the lender to carry out a hard credit enquiry, which is to say one that could affect their credit history, particularly if the application is subsequently turned down. They should also expect to have to submit details of their own personal income.
In some cases the individual offering the personal guarantee might pledge assets such as current accounts, savings accounts and property as well as pledging to cover the debt from their personal capital. This has a dual effect – it makes it far more likely that credit will be offered to the business, and it protects the lender, who knows they will have a legal right to claim personal assets if the need arises. If the individual in question has a profile and credit history good enough to back up a personal guarantee then it’s likely that this, when combined with the profile of the business, will help to improve the terms on which any loan is offered.
Why a personal guarantee could be a good idea
If you’re the owner of a small business there’s a very good chance that you’ve already invested your own capital in getting it off the ground. Bearing that in mind, it makes sense to offer a personal guarantee if this is the means by which you can access the funds needed to help the business grow and develop. As a result, the business will end up making monthly payments to the lender rather than in the form of returns for equity investors.
Different types of personal guarantee
Personal guarantees come in two different forms – limited and unlimited. The differences between the two are as follows.
A limited personal guarantee enables the lenders to collect only a specified amount of any money still owing from the individual in question. This is common practice when there are multiple individuals pledging to cover a percentage of any debt. Four directors offering personal guarantees might each limit their own liability to 25% of any debt, for example.
Under the terms of an unlimited personal guarantee, the person taking out the guarantee is liable for the full amount owed. If the lender can’t recoup all the money from funds in places such as bank accounts, they have the right to seize assets such as property or vehicles.
We can help
Offering a personal guarantee is not without risk and the experts at GoCardless can help you to decide if it’s the right course of action for you. We can also help your business to thrive by helping with ad hoc payments or recurring payments.