The recent Bank of England interest rate hike to 3% has certainly put a dampener on cheap lending but as startups seek a path through the myriad of economic uncertainty, the additional factor to consider is the high likelihood that if new finance is needed, the business founder or directors will need to sign personal guarantees.
A personal guarantee is a written promise made by a director or number of directors, to accept liability for a company’s debt. This means that if the business defaults on a loan, the director’s home, car and anything in their personal bank account could be used to settle the outstanding debt. If they co-own their home, with a spouse or partner – they will also have to sign the guarantee.
In the event that the personal assets aren’t sufficient to cover the debt, the business owner could find themselves facing bankruptcy which would have long-term ramifications and stop them from being a company director in the future.
It’s a big decision, but a decision that increasing numbers of entrepreneurs and business founders will face as lenders are becoming much more risk averse and want this additional security so that they have a greater chance if recouping their losses if the business fails.
In fact, our analysis shows that lenders are demanding a personal guarantee on a bigger proportion of a business loan than they have done previously. They are also lending to much lower numbers of startups and the value of personal guarantee backed loans has fallen by over half, over the past year.
Business start-up courses will talk about enhancing preparation for unknown uncertainties by simulating hypothetical events and assessing their effects on the balance sheet as well as day-to-day operations. This is certainly something to consider, but known uncertainties can definitely to be planned for and mitigated against.
The ability to pay back a business loan is a known uncertainty and the risk of a personal guarantee being called in should the business fail, can be mitigated in a number of ways.
Seeking independent, expert advice before signing on the dotted line from a solicitor or accountant is a good starting point. They can not only help advise on how personal risks can be cut when signing a guarantee, but also agree how the guarantee commitment could be shared with any co-directors.
Startup founders should also explore with the lender if a time limit can be agreed for the guarantee and if a cap can be set on the amount. Bear in mind though, that interest rates are rising and costs added to the debt can soon mount up.
Asking whether a lender would agree to part of the loan rather than the whole loan being guaranteed is also a possibility and if successful, another helpful way of mitigating any potential personal losses. This would mean that settlement of the debt is sought first from the company’s assets before enforcing the guarantee. Clearly, in this instance the business owner would need to show what assets within the company could be used – for example machinery, tools, or computer equipment.
The mitigation strategies we have focussed on so far have sought to reduce the amount of capital at risk under a personal guarantee by sharing it with co-directors or other company assets. Personal Guarantee Insurance (PGI) works differently and fundamentally, offers greater peace of mind and confidence to business founders when securing new finance.
With PGI in place, if the business does fail, 80% of the loan will be settled by the insurance rather than the business owner’s home, savings and other personal assets being called on to settle the debt.
As we face the bleakest economic outlook that we have seen for many years, with the economy in recession, public finances severely stretched, and high inflation driving a cost-of-living crisis it is vital to remove any barriers to startup success. With free mentoring and support services and expert guidance at the point the debt needs to be settled, PGI can help reduce anxiety, stress and uncertainty surrounding a personal guarantee, widening options and opening doors to finance that might otherwise be unobtainable.
During the past 5 years, PGI has protected 1,800 directors on over £247million of Personal Guarantee commitments – this includes close to £23million for start-up businesses, on loans from as small as £10,000 to one loan which was over £11million, with the average loan for working capital, £222,000.
Of course, signing a personal guarantee will always carry risk, but with independent advice and mitigation strategies in place, startups of all sizes can be empowered to do so, in turn benefitting from the finance they need, just when they need it, putting them in a position to weather the economic storm and come out fighting.