Lenders will sometimes ask for a personal guarantee from a company director (or directors) who wants an unsecured loan — lenders often prefer this arrangement because it lowers their level of risk. Although personal guarantees can feel like a big commitment, they often help companies secure higher levels of funding or a lower interest rate. They are also sometimes required on secured loans if the existing security is considered insufficient.
When you provide a personal guarantee to a business lender, you're agreeing to act as guarantor for the debt obligations of another party, the company where you are a director. That means if your company defaults on a loan repayment, you have guaranteed that you will pay instead.
Your obligation is secondary to the primary one between the borrower and the lender, so if your company has made all payments as they are due, or no repayments are yet due, then you can't be found in a position of liability.
Two basic features of the personal guarantee to remember:
First, the personal guarantee should not be an indemnity – which is in itself a primary obligation to pay further damages to reflect a lender’s loss – and it's not contingent on the obligations of the borrower. When examining the detail of a contract that claims to be a guarantee, it's important to recognise if you will be acting as an indemnifier, a guarantor, or a mixture of the two.
Second, your personal guarantee may or may not be supported by a security, which could be a charge over your own home, and would potentially make it easier for a creditor to seek enforcement in the event of borrower default. For larger businesses, this can also be a charge over the shares of the business.
Key Considerations
A personal guarantee will not be enforceable in any terms unless it's in writing and signed by the guarantor. Personal guarantees that are expressed as a deed and formally delivered and with wording as to that in intention are likely to be treated as unconditional.
It's unlikely that any negotiations with a creditor seeking to enforce the guarantee will be straightforward, particularly if your company’s financial situation is drifting towards insolvency – so consider any such talks early on, because the scope for reducing the liability will be connected to the prospects of recovery for the principal debt.
Sometimes the guarantee may be limited to a fixed percentage of the debt or a fixed amount so that the guarantor has more certainty..
Be objective as possible about the financial prospects of your business and its commercial value, and always remember that your guarantee is not a hypothetical . Creditors can and will enforce them, and challenging their right to — or convincing a court that a term is unfair — will never be a straightforward process.
Pros and cons of giving a personal guarantee
Pros
- Could improve the chances of getting finance.
- The interest rate on the loan may be lower.
Cons
- Risk is higher, as you have a personal risk as well as a company risk.
- Depending on the terms, it can effectively make an unsecured loan a secured loan, by charging the assets of the director.