Personal Guarantees: Reasons and Risks
The most common reason why directors will be required to provide personal guarantees is because a lender or supplier perceives a level of risk in their company. Perhaps the lender is not confident that the company’s cash flow is strong enough to fulfil its obligations. Maybe they feel that, while the company is financially secure, the sector or industry is too volatile, and they need further protection. Perhaps the company has had a history of late payments, defaults, or liquidity issues in the past.
Providing a personal guarantee might improve your company’s chance of securing funds and ultimately achieving your business goals. However, sometimes the impetus to get the deal done means that company owners and director may not give due consideration to the requirements and risks.
Below are some key issues to discuss with your solicitor.
When might you need to agree to a personal guarantee?
The circumstances when you might need to provide a personal guarantee will vary by business, but some scenarios where personal guarantees are required include when your company is:
- borrowing funds from a bank or other financial institution;
- entering into a commercial or asset lease;
- taking out a mortgage;
- buying a large consignment of goods;
- entering a substantial trade supply contract; or
- entering into an invoice finance agreement because special arrangements are required with your suppliers to support how you pay their invoices.
Why is a personal guarantee required?
Typically, a personal guarantee will come into play where the lender or creditor deems the transaction to be too risky without one, such as where:
- the lender is not satisfied that the company is able to pay its debts, if it has other liabilities on the books already, a poor credit history or insufficient funds or revenue;
- the financing sought is either risky or for a large amount, such as if your company needs an overdraft facility to cover manufacturing costs for a large customer order or your company is taking on a mortgage to purchase premises; or
- your company is a first-time customer for a supplier and your order is a large one, so they are seeking comfort that their invoices will be paid on time.
Pitfalls and risks
Giving a personal guarantee, this is not a decision to be taken lightly and several risks need to be considered:
- Future uncertainty – no one has a crystal ball and things can go wrong if your company suffers financial problems or you encounter personal difficulties. Perhaps the funds you have guaranteed are no longer available, or if you get divorced you could lose half your asset pool.
- Risk of personal bankruptcy – it is one thing for the company to suffer but the burden of bailing out your company could severely impair your own finances and even risk personal bankruptcy. Remember, it is not just the loan amount you are guaranteeing but interest payments and any applicable penalties.
- Neglecting the small print – any loan or financing comes with lots of paperwork and small print that needs to be read and understood very clearly. When you put yourself at risk, you need to ensure there are no other issues in the documentation that could trigger the guarantee, unilaterally change the terms of the guarantee, or otherwise catch you unaware.
- Term of the guarantee – beware, as some personal guarantees are drafted to last longer than the financing term and into the period covering the statute of limitation (the period of time after a contract comes to an end, during which parties may seek legal recourse). For commercial contracts, this is usually six years, and you do not want to be on the hook for any longer than necessary.
- Co-founders – where a business has more than one director or owner, you should consider who will provide the personal guarantee. Even if another director provides it or you provide a pro-rated guarantee, you take on the risk of your business defaulting and potentially expose yourself to the credit risk of your fellow co-founders.
Important clauses in the personal guarantee
Not all personal guarantees are equal and a few of the most important clauses include:
- The payment obligation – it is important to ensure you know the detail of your obligation. Is it to cover all outstanding debts of the company? Or a certain amount? Will interest or other charges be added to your liability?
- The right to terminate – most guarantees continue for a long time and tend to restrict the ability of the guarantor to terminate. When your company has been relieved of its obligations, you will want the guarantee to terminate. If the original documentation which gave rise to the guarantee (loan document or lease agreement) is subsequently amended, it is advisable to limit the scope of the guarantee so that future amendments do not automatically apply in case they increase your liability. Some guarantees may include conditions that need to be satisfied to release you from the guarantee. These ought to be reviewed carefully to ensure they are both reasonable and not a back door to keeping you on the hook beyond what is intended.
- Caps on personal assets – putting your personal wealth on the line is a big risk for any business owner. If the creditor is open to negotiating a cap on the exposure under the guarantee, that would at least mitigate your own losses in the worst-case scenario.
Of course, the above are not exhaustive and unfortunately there is the possibility that a personal guarantee can be obtained through fraud or deceit.
How we can help
Our commercial team has extensive experience with protecting small and medium company owners and advising on any personal guarantee requests from creditors.
For further discussion, please contact Clare Richards in the corporate and commercial team on 01473 611211 or email firstname.lastname@example.org.
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.