What Is a Personal Guarantee on a Business Loan?
Updated: Aug 17
If you are a director or shareholder applying for business finance, you may be asked to provide a personal guarantee.
Personal guarantees are common in SME lending, particularly where a limited company is borrowing without providing specific asset security.
A personal guarantee is important because it can make the guarantor personally responsible for money owed by the company if the business fails to repay the lender.
It should therefore never be treated as simply another signature required to complete a business loan.
How does a personal guarantee work?
A limited company is a separate legal entity from its directors and shareholders.
Normally, a debt owed by the company is therefore the company's liability rather than the personal liability of its directors.
A personal guarantee changes this position.
The guarantor agrees that if the company doesn't meet specified obligations to the lender, the lender can seek payment from the guarantor in accordance with the terms of the guarantee.
For example, if a company takes out a £50,000 business loan supported by a director's personal guarantee and subsequently defaults, the lender may be able to pursue the guarantor for amounts covered by the guarantee.
The precise liability depends on the wording of the guarantee.
Why do business lenders ask for personal guarantees?
Small and medium-sized businesses are often closely associated with their owners.
A company may have limited assets of its own, particularly where it provides services rather than owning substantial property, machinery or stock.
A personal guarantee provides the lender with additional protection if the company fails.
It also aligns the interests of the individuals behind the business with those of the lender.
For this reason, personal guarantees are particularly common in unsecured SME lending.
Is a personal guarantee the same as security?
Not exactly.
A guarantee creates a personal obligation from the guarantor.
Security gives the lender rights over a particular asset.
For example, a lender might have:
An unsecured business loan with a personal guarantee: no particular asset is charged to the lender, but a director guarantees the company's obligations.
A secured business loan: the lender takes security over a specific asset, such as property.
It is also possible for a lender to require both security and personal guarantees.
This is why an "unsecured business loan" doesn't necessarily mean that a director has no personal exposure.
Do all business loans require a personal guarantee?
No.
Requirements vary considerably between lenders and products.
Whether a guarantee is required can depend on:
the amount being borrowed;
financial strength of the company;
type of facility;
availability of security;
lender's credit policy; and
ownership structure of the business.
Some lenders may provide certain facilities without personal guarantees, while others routinely require them.
If a guarantee is required, the borrower and guarantor should establish this early in the application process.
Who normally provides the personal guarantee?
Usually, personal guarantees are provided by the directors or significant shareholders behind the business.
Where a company has several owners, the lender may require guarantees from more than one person.
The requirements will depend on the lender and the ownership and management structure of the company.
A lender will generally want the people providing guarantees to have a meaningful connection with the business.
Is a personal guarantee limited to the loan amount?
Not necessarily.
This is an important point.
Some guarantees are limited to a specified amount. Others can cover the company's wider obligations to the lender.
The guarantee may also provide for additional amounts such as interest, costs or expenses in certain circumstances.
A guarantor should therefore not assume that signing a guarantee for a £50,000 business loan automatically means that £50,000 is the absolute maximum possible liability.
The terms of the particular guarantee need to be read carefully.
Does giving a personal guarantee affect my credit score?
Providing a personal guarantee doesn't necessarily have the same effect as personally taking out a consumer loan.
However, lenders may carry out credit searches on proposed guarantors as part of assessing a business loan application.
The implications can depend on the type of search, lender and credit reference agency.
More importantly, if the company subsequently defaults and the lender enforces the guarantee, the consequences for the guarantor can become considerably more significant.
If you're concerned about how a particular lender conducts its searches, ask what type of credit search will be undertaken before proceeding.
Does a guarantor need to be a homeowner?
Not always.
Different lenders have different requirements.
Some business lenders prefer or require guarantors to be homeowners, particularly for larger or higher-risk facilities. Others may consider non-homeowner guarantors.
Homeownership can provide a lender with additional comfort regarding the financial position of the guarantor, although owning a home doesn't by itself determine whether a business loan is affordable or appropriate.
The lender should still primarily assess the company's ability to repay the borrowing.
Is my house automatically at risk if I sign a personal guarantee?
Signing a personal guarantee doesn't normally mean that the lender automatically has a mortgage or charge over your home.
A personal guarantee and property security are different legal arrangements.
However, that doesn't mean personal assets can never be at risk.
If a company defaults and the guarantor becomes liable under the guarantee, the lender may pursue the guarantor for the money owed. If the debt remains unpaid and the lender obtains the necessary legal remedies, the guarantor's assets could potentially become relevant to enforcement.
The consequences can therefore be serious even where no property was specifically charged when the loan was made.
What happens if the business misses a payment?
A missed payment doesn't necessarily mean that the lender will immediately pursue the guarantor.
The initial response will depend on the lender, the loan agreement and the circumstances.
The lender may first contact the company to understand why the payment was missed and seek payment of the arrears.
However, persistent non-payment, no response from the borrower, or another event of default can ultimately result in the lender terminating the facility or demanding repayment.
At that point, the lender may also seek payment from guarantors in accordance with the guarantee.
What happens if the company becomes insolvent?
A personal guarantee doesn't normally disappear because the company enters liquidation or another insolvency process.
Indeed, company insolvency is one of the circumstances in which a guarantee can become particularly important.
If the company cannot repay the lender, the lender may seek to recover amounts covered by the guarantee from the guarantor.
The lender may also have a claim within the company's insolvency.
Again, the precise position depends on the loan and guarantee documentation.
Can a lender pursue a guarantor without pursuing the company first?
Potentially.
A guarantor shouldn't assume that a lender must exhaust every possible recovery route against the company before making a demand under a guarantee.
The lender's rights will depend on the wording of the particular documentation and the circumstances of the default.
Modern commercial guarantees can give lenders extensive rights.
This is another reason why a personal guarantee should be understood before it is signed.
Can I negotiate a personal guarantee?
Sometimes.
Whether a lender is prepared to negotiate will depend on the transaction and its credit policy.
Possible areas of discussion could include:
limiting the maximum guaranteed amount;
reducing the guarantee as the loan amortises;
releasing the guarantee once certain conditions are met; or
providing alternative security.
However, a lender is under no obligation to accept these changes.
For some lending products, the required guarantee structure will simply form part of the lender's standard credit criteria.
Should I get legal advice before signing a personal guarantee?
If you don't understand the guarantee or the potential consequences, obtaining independent legal advice is sensible.
For some transactions, the lender may require a guarantor to obtain independent legal advice before completion.
The important point is to understand what you are guaranteeing, when the lender can make a claim and the extent of your potential liability.
You shouldn't sign a personal guarantee on the assumption that it will never be enforced.
What should I check before signing?
At a minimum, understand:
which obligations you are guaranteeing;
whether your liability is capped;
whether interest and enforcement costs can be added;
when the lender can make a demand;
whether the guarantee continues if the loan terms change;
how the guarantee can be released; and
whether any separate security is also being provided.
If anything isn't clear, ask the lender or obtain appropriate legal advice before signing.
Personal guarantees and Adelpha Capital business loans
Adelpha Capital provides business finance to established UK SMEs, and a personal guarantee is required.
A guarantee provides additional protection to the lender, but it doesn't replace our assessment of the underlying business. We still consider factors such as turnover, cash flow, recent bank conduct, trading history and existing borrowing when deciding whether a loan is appropriate.
If you're considering business finance, you can apply online or contact the Adelpha Capital team to discuss your requirements.