September 2021 brought sobering news of an 18 month high in registered company insolvencies[i]. Many small and medium sized businesses are now facing a very bumpy ride as pandemic support measures such as VAT deferrals and the commercial rent moratorium, ease back. For those business owners and founders who have taken the serious step of putting their personal assets such as their home and life savings on the line to secure a business loan, this will be a very worrying time.
At Purbeck Personal Guarantee Insurance we have estimated that over 420,000 small business owners in the UK were acting as personal guarantors for business loans prior to the pandemic. By providing a personal guarantee in support of a business loan, the director is providing the lender with recourse to his/her personal estate which, in effect, lifts the veil of incorporation afforded through a Limited Company or Limited Liability Partnership. Furthermore, based on a Freedom on Information request, we have calculated that £2.1bn in CBIL loans were taken by business owners and directors which had personal guarantees attached[ii].
The problem is that SME access to finance is increasingly going to necessitate signing a Personal Guarantee as lenders become more risk averse. So if you haven’t yet faced this prospect, you probably will, if or when you need new funding.
At the same time, the risk of signing a Personal Guarantee has increased following new insolvency rules introduced in December 2020 which made HMRC a preferred creditor in a business insolvency. In essence this may reduce the ‘pot’ of funds left to pay existing Personal Guarantee backed loans meaning that a director or business owner could find that as the loan is called in, their personal assets need to be used to settle the debtii.
It is therefore crucial SME owners and directors understand how they can mitigate the risks of signing a Personal Guarantee, with Personal Guarantee Insurance becoming an increasingly common option.
What is a Personal Guarantee?
Personal Guarantees give the lender a written promise, made by a director or number of directors, to accept liability for a company’s debt. In practice, this means that if the business defaults on a loan the director’s home, car and anything in their personal bank account could be called on to settle the outstanding debt. You could even find yourself facing bankruptcy if your personal assets don’t cover the debt. This obviously has much longer term ramifications, including prohibiting you from being a company director in the future.
If you co-own your home, with a spouse or partner – they will also have to sign the guarantee. A minority stake holding in the business won’t protect you either as a lender will go after whoever has the most chance of settling the debt.
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. In addition, the Government backed CBILS (Coronavirus Business Interruption Loan Scheme) and the Recovery Loan Scheme permits the use of Personal Guarantees as security for loans over £250,000.
The Personal Guarantee Dilemma
Signing a Personal Guarantee to secure access to funding is a risk some small business owners are willing to take while others see it as a step too far. In a survey Purbeck Personal Guarantee Insurance conducted earlier this year amongst 1000 SME owners and directors[iii], 45% said they had decided against a loan because it required a Personal Guarantee, but 64% said they would be more likely to sign a personal guarantee if there was insurance in place to protect against the risk of providing it. Most notably, an overwhelming majority (88%) agreed that lenders and financial advisers have a duty to make business owners aware of Personal Guarantee Insurance.
Over £120m in SME Personal Guarantees Protected By Insurance
Personal Guarantee Insurance has protected over £120 million in Personal Guarantees over the last three years, giving business owners and directors the confidence to secure finance knowing that if the business fails, the majority of the loan would be paid off without risk to their home and assets. Amongst start-ups alone, loans to the value of £35million have been protected by Personal Guarantee Insurance.
Just like any other insurance it protects against the risk of the worst happening – in this instance the risk that your business fails and the guarantee is called in by the lender. Insurance will offset any outstanding obligations called in with the level of cover 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.
The big difference with this type of insurance is it does a lot more than simply pay out following a claim. Personal Guarantee Insurance includes access to free mentoring and support services if your business gets into financial distress, plus the huge benefit of expert guidance at the point the debt needs to be settled. This takes a huge burden off the shoulders of the business owner.
Other ways to mitigate the risks
Before deciding that signing a Personal Guarantee is right or wrong for you, it is always important to get some independent advice. Your accountant, solicitor, commercial broker or financial adviser can all 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 run your business with co-directors, come to an agreement to share the guarantee. You can also negotiate a time limit for the guarantee and a cap on the amount, but do remember interest and costs added to the debt can soon mount up.
You may also be able to agree terms where you are guaranteeing a part of rather than the whole loan and that settlement is sought first from company’s assets before enforcing the guarantee.
Don’t let a Personal Guarantee be a barrier
Whether your SME business needs funding to start, sustain or grow, a Personal Guarantee shouldn’t stand in the way of the finance you need. Seek expert advice and look at the ways you can mitigate the risk, including Personal Guarantee Insurance, before signing on the dotted line.
[ii] FOI Request in April 2021 for breakdown of CBILS loans secured over £250,000 where a personal guarantee was required by the lender, up to 31st March 2021
[iii] Survey conducted May 2021 via Cision of 1000 SME Owners and Directors