Most small businesses will have used financing, either to start up or grow, but lending criteria can be variable, and in many cases, lenders will ask for a personal guarantee.
But what is a personal guarantee? What happens if you’re asked to provide one? A personal guarantee is an agreement between a lender and a business owner or director. This document makes the individual liable for finance repayments if the business itself can’t pay.
Experian research shows how business credit scores suffered as a result of the COVID-19 pandemic, and while recovery has been swift on the whole, it was a stark reminder that situations can change in an instant.
Ultimately, lenders want to minimise risk as much as possible, and a personal guarantee is one way they can do that if a business has a less than satisfactory business credit score, a limited history, and/or limited assets to secure a loan against.
Would Your Business Benefit from a Personal Guarantee?
With various options available for businesses in need of financing, and with various levels of eligibility criteria, it’s helpful to know that the option is there to offer a personal guarantee if your business doesn’t tick all the boxes for a lender.
Many small business owners are happy to sign a personal guarantee agreement, particularly if it’s the only way for them to access funding for their business. It might be that the business is so new, perhaps even in the start-up phase, so it hasn’t had the opportunity to build an adequate credit history. Perhaps the business credit score isn’t robust enough for a particular lender, or the amount you’re looking to borrow is higher than they’d be willing to risk without more of a guarantee.
To help you understand more about these arrangements, and what it might mean for you, here are the pros and cons of personal guarantees:
Pros
- Can enables your business to still obtain key financing if you don’t meet certain criteria
- Gives you the opportunity to borrow more money than your business alone might be eligible to.
- Can open up more opportunities to you that all lead to business growth - buying more equipment, investing in your workforce, responding to market demand, levelling up your technology, improving working capital, and more.
- Relatively affordable option for new businesses with limited to no trading/credit history.
- Encourages a happier relationship with your lenders by reducing their risk
Cons
- Requires a strong enough personal credit score to have the opportunity to enter into a personal guarantee agreement.
- Can come with personal repercussions if you cannot meet your obligations. If your business is unable to satisfy the arrangement, it will fall to you to make payments. Failure to do so could lead to your personal assets (such as your home or car, or both) being sold.
- If you’re unable to repay the loan yourself and your assets don’t cover the amount needed, you risk going bankrupt.
- Any issues satisfying the agreement could lead to problems being a company director in the future – it’s something you may even need to go to court for permission to do.
- No matter what happens to the business, a personal agreement means that you can still be pursued for repayments.
Making the Right Funding Choice for Your Business
We often hear from small business owners who are frustrated that they’re not able to access the funding they need, even though they know the business will be able to satisfy the debt. If you’re completely confident that there won’t be an issue with your business’s ability to make repayments, agreeing to a personal guarantee could be an easy decision to make.
There are still of course risks, as outlined above, but they can be mitigated. Perhaps you could split the guarantee with other directors so it’s not solely on your shoulders, or even take out personal guarantee insurance.
Before you make the final decision, make sure you’re fully aware of the potential benefits of consequences of a personal guarantee. Taking legal and/or financial advice is also recommended. In the meantime, building your small business credit is a valuable way of strengthening your business’s financial position, and a small business credit card from Capital On Tap can help.
