Mitigating the risks of giving a lender a personal guarantee

As a small business, accessing finance with favourable terms can be hard and so you may consider agreeing to give a personal guarantee to a lender to help alleviate cash flow or fund the growth of your business. However, while a personal guarantee may allow you to gain better terms or an extended credit line, it may come with considerable risks which need to be evaluated carefully.

Lenders often advise their clients to get independent legal advice before they sign a personal guarantee and there are good reasons for this. Weighing up the advantages of a personal guarantee against the risks is one reason to seek legal advice, but an even more important reason is the need to negotiate equitable terms within the personal guarantee itself. Your personal assets and reputation will be at risk, and so it is critical to have the best possible protection.

What is a personal guarantee?

A personal guarantee is a legally binding document between a financial lender and business borrower to secure a loan that exists between the lender and borrower. It essentially puts the business owner or director on the hook to repay the loan if it cannot be repaid by the business, as they agree that their personal assets and finances can be used as collateral.

Advantages of a personal guarantee

Small business loans can come with higher interest rates as lenders try to manage their exposure and the uncertainty associated with a fledgling or small business. Adding a personal guarantee as a form of security can therefore add liquidity to the business, increase cash flow, or even allow for the negotiation of reduced interest rates down the line.

A personal guarantee may be simpler or quicker to arrange than having to source additional finance from other lenders at potentially worse terms.

If the benefit your business gains is relatively small or risk free, then a personal guarantee can be a great option to access a better credit line. For example, if you need a line of credit to help you bridge the cash flow between sourcing materials for your goods and actually selling them, this risk could be considered fairly short term and of low value. Therefore, the benefits attached to providing a personal guarantee may be viewed as outweighing the risks.

Risks with a personal guarantee

In contrast, the risks associated with a personal guarantee can be quite heavy depending on the financial terms and what the legal language states within the personal guarantee document. By guaranteeing the performance of your business, you agree to put your personal assets up as security and so the risks can include, but are not limited to:

• the lender enforcing the guarantee and you losing personal assets that are subject to the personal guarantee, such as your home, valuables and even cash in your personal accounts;
• calling on the guarantee could disrupt your personal credit score which could have consequences on your ability to open investment accounts, bank accounts or get personal loans;
• any default by your business on a loan and the subsequent enforcement of the personal guarantee could negatively affect your business reputation, supply chain, cash flow and ultimately its viability; and
• similarly, the potential loss of your personal assets could, in the worst case, open you up to personal bankruptcy.

Making a personal guarantee work for you

While giving a personal guarantee may be daunting, this is where the real importance of seeking professional legal help comes to the rescue.

It is possible to obtain the benefits of a personal guarantee while mitigating the risks outlined above. Careful attention to the terms and conditions of the guarantee and effective negotiation will help you achieve your goals.

Here are a few examples of common pitfalls that can be negotiated favourably:

• Loan to value cannot be excessive - the personal guarantee value cannot exceed the loan to value and often can be negotiated down to truly reflect the lender’s concern or risk.

• Interest rate reduction - depending on the other terms of the guarantee, there could be a potential to negotiate reduction in interest rates commensurate with the security provided by the personal guarantee.
• Term of the personal guarantee - ensuring the term is not unnecessarily longer than required reduces the risk. For short term credit lines, it does not make sense for the personal guarantee to be in place for longer than it needs to be (10 years in this example would be too long).
• Release terms - personal guarantees should be released upon the repayment of the loan, if you decide to sell on your business, or if the purpose for the personal guarantee is no longer relevant.

After careful evaluation of your circumstances, it may be necessary to explore other options to help you achieve your goals without the need for a personal guarantee, such as invoice financing or personal guarantee insurance. These are options that would be discussed with you if appropriate.

How we can help

Our team of commercial solicitors can work with you to ensure you understand the terms of a proposed personal guarantee, and can negotiate to mitigate any risks. We can provide a holistic view after carefully analysing your goals, circumstances, risk appetite and commercial position.

For further information, please contact a legal adviser in our corporate and commercial team.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.