Signing a personal guarantee for a start-up loan
By Todd Davison, MD, Purbeck Personal Guarantee Insurance
Interest rate hikes have curbed cheap lending options but as start-ups seek a path through economic uncertainty, the additional risk to consider is that if new finance is needed, the business founder or directors will probably need to sign personal guarantees as security for the lender.
What is a personal guarantee?
So what is a personal guarantee? A personal guarantee is a written pledge made by a director or number of directors, to accept liability for a company’s debt should the stat-up business fail.
What happens when a business fails
No-one starts a business expecting it to fail but company insolvencies have been rising (up 16% in March 2023), underlining the challenges of running a business in the current environment. With a personal guarantee in place, 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 the home is co-owned – the co-owner will also have to sign the guarantee.
If personal assets don’t cover the debt
Bearing in mind that the current average personal guarantee backed loan through the Recovery Loan Scheme is £472k, and the average house value is £288k, there might even be the possibility that the personal assets aren’t sufficient to cover the debt. In this case, the business owner could find themselves facing bankruptcy which would have long-term emotional and financial ramifications and stop them from being a company director in the future.
More start-ups take personal guarantee insurance in Q1 2023
Signing a personal guarantee is a major decision that increasing numbers of entrepreneurs and business founders now face. We’re seeing this trend in the volume of applications for Personal Guarantee Insurance from start-up businesses which was 37% higher in Q1 2023 than Q1 2022.
Demand from lenders for security
Our analysis also shows that lenders are demanding a personal guarantee on a bigger proportion of a business loan than they have done previously with Personal Guarantee commitments in 2022 on average £124,992 up from, £84,942 in 2021. To help mitigate the personal risk this poses, founders of startups were insuring on average £113,492 through Personal Guarantee Insurance in 2022 compared to £72,768 in 2021.
What can be done to reduce the risk of personal guarantees?
The risk of signing a personal guarantee can be mitigated in a number of ways.
Seeking independent, expert advice from a solicitor or accountant is a good starting point. Consider sharing the guarantee with co-directors too.
Start-up founders should also explore with the lender if a time limit can be agreed for the guarantee and if a cap can be set on the amount. Bear in mind though, that interest rates are rising and costs added to the debt can soon mount up.
Asking whether a lender would agree to part of the loan rather than the whole loan being guaranteed is also a possibility and if successful, another helpful way of mitigating any potential personal losses. This would mean that settlement of the debt is sought first from the company’s assets before enforcing the guarantee. Clearly, in this instance the business owner would need to show what assets within the company could be used – for example machinery, tools, or computer equipment.
Personal Guarantee Insurance
Then there’s Personal Guarantee Insurance (PGI). With this relatively new type of insurance in place, if the business does fail, 80% of the loan would be settled by the insurance rather than the business owner’s home, savings and other personal assets being called on to settle the debt. There would also be mentoring advice and support at the point the debt needs to be settled, taking a big burden off the shoulders of the business owner at what can be a very stressful time.
It is certainly gratifying to see that women created record numbers of businesses in 2022 despite a huge disparity in the level of financing women are securing compared to men. Over the past 5 years, just 10% of people taking PGI for a business loan have been women.
Running a business can be hugely rewarding but also incredibly tough – and it is perhaps tougher now than it has been for some time – founders need to be realistic about the financial risks and go into ventures knowing exactly what they can do to limit them.