In recent months, personal guarantees have been hot topic, with the Federation of Small Business (FSB) suggesting that they could pose potential barriers to small businesses. Guarantees do have a place and we feel that it is our job as a finance broker to educate businesses on their correct purpose, what to look out for when signing them, and the potential impact it could have on the directors if these are enforced.
What is a personal guarantee? In simple terms it is a promise to pay if the business fails to keep up the payments. This is typically asked for from all shareholders of a business, if a director is in name only, generally a guarantee isn’t required from these individuals. Guarantees can be asked for in all types of finance (including hire purchase and lease) and will always be required in the loan space.
In asset finance guarantees are never secured on property. If there is a requirement for home ownership this is only because statistically it is far harder for an individual who owns property to disappear quickly without trace – it has nothing to do with taking security. In the event that the business was struggling the equipment could be sold with the proceeds settling the finance, meaning the guarantors would only have to cover the shortfall.
Why would personal guarantees be requested?
Focus only request directors’ guarantees where necessary, and typically this is in the following three scenarios:
- If the business has been trading for less than 3 years
In the early years is when businesses are most likely to go wrong, and there is little proof of concept or previous trade to demonstrate repayment ability. - The majority of profits are being removed from the business by way of dividends, leaving the business with little to modest net worth
- The net worth of the business is less than the amount to be financed where the equipment being financed has little residual value in a forced sale scenario
This point is less clear cut, however the amount you can fund without a guarantee for assets such as vehicles or plant and machinery is significantly more than items such as IT solutions or coffee machines. This is because if the business can’t keep up the payments the funder will look to recoup and sell the asset, of course this is much easier with a second hand vehicle compared to a used coffee machine!
When should you offer guarantees?
This is slightly different for each business, but you have to be confident that the broker you are working with is asking for guarantees for the right reasons.
Ultimately if you have faith in your business, then there should be no issue with giving a guarantee and if you don’t then should you expect someone else to trust the business will keep up the payments?
Considerations
When offering a personal guarantee there are a couple of things to check/consider:
- Is any security over property being taken? More typical in the loan space than asset finance, as the asset provides some security.
- Do you have issues with your personal credit? If so, this is likely to cause issues, so be honest and up front with your broker.
- Are you confident that your business will be able to maintain the payments?
- Can you afford not to offer a guarantee? If a guarantee is the only way to gain an approval for equipment required for a new contract or to improve productivity, this could ultimately damage the profitability.
There are also insurances that can be taken out to cover costs if a personal guarantee did have to be acted upon. There is a cost attached to this, but it may be an option to explore to give the extra confidence.
In conclusion, if you are confident in your business and the purchase you are making is sensible and will generate income/save time, then signing a guarantee should be something you can be comfortable with. Having said that guarantees are not black and white, so we are always happy to have a conversation to discuss the options that may or may not be available to you.