National insolvency and turnaround solutions specialist Jirsch Sutherland is reminding SME owners of the risks involved, alongside the potential rewards, of issuing personal guarantees for business debts.
A personal guarantee (also known as a director’s guarantee) is defined as a promissory document provided to lenders and credit by a company’s director or directors to accept liability for a business’s debt. This means if the business defaults, the director’s home, car and money in their personal account could be used to settle the outstanding debt. Such guarantee also extends to the director’s spouse or partner who might share ownership with the assets, as they will also have to sign the guarantee.
“Personal guarantees are commonplace, and with the current economic volatility, more and more lenders and creditor providers are requiring them,” Malcolm Howell, a Jirsch Sutherland Partner and Bankruptcy Trustee, explained. “They’re usually provided for vehicle finance, debtor factoring/invoicing facilities, overdrafts, term loans, and for credit applications for the supply of goods.”
“But, as common as they are, they’re also often described as a business owner’s ‘Kryptonite’, Howell added. The use of personal borrowings and mortgage guarantees for business borrowings increases household and individual financial vulnerabilities. They have the potential to bring you down financially and ruin your financial freedom. That’s why speaking with a trusted adviser early on should be at the top of your list when you’re starting or running an existing business. Understand the risks and how to protect your assets and yourself.”
Howell noted that a significant proportion of personal insolvencies is the result of a failed business, saying that he has seen many SME directors go into bankruptcy because they’ve provided personal guarantees on business debts.
“In the event of a default on a loan, or if the business goes into external administration, if the guarantee holder (creditor) doesn’t receive sufficient funds, which is often the case, they can pursue the director for the debt owned by the corporate entity,” he cautioned.
Howell also urged individuals to be aware of the impact of personal guarantees on personal debt. He also shared some important matters to keep in mind before issuing a personal guarantee:
- If setting up a business or corporate entity, advice must be first sought on the appropriate type of structure.
- Seek advice first on how to structure personal assets and/or jointly held assets.
- Read the fine print and review every loan or credit application to understand exactly to what extent the personal guarantee is being offered.
- Negotiate and amend any document to limit personal exposure to corporate debt.
- Keep a register and copies of all documents and credit applications that have been signed and that contain personal guarantee clauses.
