By: Todd Davison, MD, Purbeck Personal Guarantee Insurance
Starting a business is one thing but keeping it going often needs extra cash and while there is a good choice of funding options to consider, as a start-up it is unlikely you will have security in the business to offer the lender. This means you may need to sign a personal guarantee.
For some people, signing a personal guarantee is part and parcel of the risks involved in starting a business, for others it is a source of stress and anxiety, not just for themselves but for their families too. The good news is that there are ways to mitigate the risks.
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. This means that 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.Therefore, if you co-own your home, with a spouse or partner – they will also have to sign the guarantee.
If your personal assets aren’t sufficient to cover the debt, you could find yourself facing bankruptcy which would have long term ramifications and stop you from being a company director in the future.
It’s important to understand that a lender will go after whoever has the most chance of settling the debt so a minority stake holding in the business won’t protect you either.
No-one starts a business expecting it to fail but as the pandemic has shown, events can happen that are completely out of our control. Therefore, if you sign a personal guarantee it is vital that you not onlyfully understand the risksbut also how to cut them.
What type of finance requires apersonal guarantee?
Personal Guarantees can apply to a wide range of loan facilities including those available from P2P lending platforms – in fact at Purbeck we see 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 for you, get some independent advice. An accountant, solicitor, commercial broker or financial adviser can help you work out the best options for your business and advise on the additional ways you can cut the personal risks you might face by signing a personal guarantee.
For example, if you started the business with co-directors, come to an agreement to share the guarantee. Work out with the lender if you can agree a time limit for the guarantee and a cap on the amount but bear in mind that while interest rates are low, they are set to rise and costs added to the debt can soon mount up.
You may also be able guaranteepart of rather than the whole loan and that settlement of the debt is sought first from company’s assets before enforcing the guarantee. Clearly in this instance you will need to show what assets within the company could be used – this could be machinery, tools, computer equipment.
Personal Guarantee Insurance
In addition to the steps above, a growing number of start-ups are turning to Personal Guarantee Insurance to mitigate the risk.In fact entrepreneurs in the UK collectively secured £35 million of funding for a new venture in the past three years through personal guarantee backed loans that were protected by Personal Guarantee Insurance. 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.
Just like any other insurance it protects against the risk of the worst happening – in this case business failure. If the guarantee is called in by the lender because the business has defaulted on the loan, the insurance will offset any outstanding obligations. The level of cover is based on a fixed percentage of the personal guarantee the company director wishes to insure. This is dependent on whether the corresponding finance facility is secured or unsecured.
Mentoring support part and parcel of cover
Personal Guarantee Insurance also does a lot more than pay out following a claim. Policyholders are offered access to free mentoring and support services if their business gets into financial distress, plus the huge benefit of expert guidance at the point the debt needs to be settled.
Don’t let a Personal Guarantee stand in the way of your ambitions
If you need funding to start, sustain or grow your business, a Personal Guarantee shouldn’t be a barrier. Ensure you have benefited from expert, independent advice and look at the ways you can mitigate the risk, including through Personal Guarantee Insurance.