When exploring finance options for your business, the provider of a business loan or other source of funding may ask you to provide a personal guarantee. Although a personal guarantee is not uncommon, there seems to be a lack of understanding from small business owners about exactly what it means.

Research by an SME loan provider found that more than half (55 percent) of 510 SME senior decision makers did not know what a personal guarantee was. 21 percent of those thought it was a commitment from the business owner to repay the money to their best of their ability, while 61 percent believed personal guarantees related to business rather than personal assets.

With so much confusion out there, it’s perhaps not surprising that many business owners have agreed to provide a personal guarantee for business finance while being unaware of the potential risks.

What is a personal guarantee?

A personal guarantee is an agreement between a third-party finance provider and a business owner or director. It stipulates that if the business cannot repay the debt, the business owner will be personally liable for the repayments. In simple terms, that means if the company defaults on the repayments, your personal assets and even your home could be at risk.

From a lender’s perspective, a personal guarantee makes a finance agreement more secure because the responsibility for the repayments falls on both the company and the directors personally. So, even if the company were to become insolvent, the finance provider can still pursue the business owner for the debt. From a CEO’s point of view, signing a personal guarantee may allow you to access finance that might not otherwise be available – and besides, you’re confident the company will make the repayments anyway.

What are the typical terms of a personal guarantee?

If you are considering becoming a personal guarantor for a business loan, it’s essential you understand the basics of the contract you’re entering into. You should only ever agree to a personal guarantee when you are comfortable with the terms. You need to know:

• How will creditors enforce the guarantee?
• What constitutes a default?
• Does it include a remedy period?
• Is there any cap on your level of personal liability?
• Will the lender try to recoup the debt through other means before making demands on you?

Prior to signing the guarantee, it may be possible to reach an agreement to cap your liabilities. Although this won’t possible with all lenders, it could provide some reassurance and potentially mitigate your losses further down the line.

Why should you consider personal guarantee insurance?

Personal guarantee insurance is a product that’s relatively new to the UK. It provides protection for the personal assets of a CEO when they have signed a personal guarantee for a business loan. If the business is unable to repay the loan, the insurance policy will cover a proportion of the net liability, depending on the terms of the policy. That can provide a safety net for the business owner and their family and reduce some of the stress and anxiety associated with personal guarantees.

Mike Smith of Business Expert advises business owners to be wary of signing a personal guarantee. “Before committing to any finance solution that requires a personal guarantee, business owners should always make sure they have investigated all their options. There are numerous financial routes open to SMEs, many of which don’t place such tremendous pressure on the business owner personally.

“If you are struggling to find an appropriate solution or are considering signing a personal guarantee, I’d always advise seeking the assistance of an impartial expert first. They will help you understand exactly what the provisions could mean further down the line.”