Taking out a business loan can help business owners to unlock new growth opportunities, so it is unsurprisingly a popular option for entrepreneurs seeking commercial funding.
If the business is successful, it is also an excellent opportunity for lenders, who will earn interest on the loan, and have it repaid in full – but what happens when this isn’t the case?
In the case that the business does not meet it projected turnover and is unable to pay its loan, lenders will find themselves in a difficult position.
For this reason, many commercial banks and other lenders seek to protect their investment with a legally binding guarantee that the borrower will repay the loan, plus interest.
For smaller businesses, one of the more common ways of doing this is through a personal guarantee.
What is a personal guarantee?
This is an assurance from a business owner, partner or other executive that they will personally assume the debt if the business is no longer able to make its repayments.
While clearly a potential door to higher loans and more favourable terms, this can represent a significant risk to borrowers.
For business owners looking to secure a loan through a personal guarantee, it is first important to understand the two types and how they might impact personal finances.
Limited vs unlimited
There are two types of personal guarantees which may be used – limited and unlimited.
An unlimited guarantee, also known as an unconditional guarantee, means that the guarantor (the person giving the guarantee) is required to pay all amounts due to the lender.
As the name suggests, unlimited personal guarantees allow the lender to recover the entire loan amount, plus interest and legal fees, by whatever means possible, if the borrowing business defaults on its loan.
This means they can take money from a director or guarantor’s personal assets, such as savings or properties.
In contrast, a limited guarantee allows the lender to recover only a certain percentage of the loan from a given individual. This is commonly used when there is more than one director or guarantor covering the value of the loan.
Which is better?
It depends on the point of view!
For lenders, to obtain the best security, it is generally best to obtain an unlimited personal guarantee.
For borrowers, it is clearly best to negotiate a limit on the sum of money that the lender can recover under the personal guarantee, and this should be no more than the value of the loan.
In practice, it is usual a personal guarantee to be limited, but the interest and expenses will be payable in additional to the amount secured through the guarantee.
The costs associated with the preparation and completion a personal guarantee is likely to be in the region of £500 to £1,500 (plus VAT and disbursements).
For further advice on obtaining or using a personal guarantee, please contact our team of experts today.