I am frequently asked by clients whether they should give a personal guarantee (“PG”) on behalf of their business or for a friend or family member. The short answer to this question is: “No!” and failing that, “Not if you can help it”.
However, there may be personal situations where you may be asked to provide a PG and where it might be difficult to say “No”… I remember, when I was at university in Leeds I asked my father to guarantee my rent (I cannot recall whether or not he agreed) and most mortgagees are asked to guarantee their mortgage payments.
If you start a business and apply for funding by way of a loan or overdraft, it is more than likely that you will be asked to give a PG in the unthinkable event that the business fails. You may also be required to give a guarantee if you purchase a franchise.
The Bottom Line Is…
You should only provide a guarantee after you have given full and proper consideration to the potential liabilities to which you will be exposing yourself. In particular, unlimited guarantees are to be avoided if at all possible, especially in relation to business.
Financial Lending Guarantees
There are several ways in which lenders seek to obtain PGs:
1) from directors of a limited company
2) from partners in a partnership
3) from people otherwise involved in the business
4) from an external guarantor, who may not be willing to invest directly but will risk providing a guarantee. (In these circumstances the guarantor is usually paid a regular fee or a one-off payment of generally between 2-3% of the total amount guaranteed.)
Limited Liability and PGs
One of the benefits of setting up your business using a limited liability structure is that in the even of failure of your business, the limited liability element will prevent directors and/or shareholders from being sued by creditors for your personal assets. However, businesses that do not have a track record may not be able to obtain credit of their own volition, hence the need for PGs.
In the event that the bank demands repayment of the loan, the guarantor will be liable for the amount that they have guaranteed. If you have guaranteed an amount with one or more other individuals, you may be liable for the debt on a ‘joint and several liability’ basis, i.e. that each individual guarantor is liable for the whole amount in the event that the other guarantors cannot pay it. As previously stated you should beware of unlimited guarantees for the same reason. However, the Banking Code requires that guarantees for unlimited amounts should not be given in relation to bank account borrowing.
Guaranteeing Someone Else’s Business
You may think that you are being supportive to a spouse, partner, family member or associate but all too often people sign PGs without having given thought to what could happen in the event of default. Consider the effects of relationship break-ups, divorce and lost friendships – any one of these could leave you to carry the burden for a debt that you haven’t personally incurred, in a business that you never had anything to do with… Don’t leave yourself unnecessarily exposed – it would be far better to disappoint someone at the outset than put yourself, and your relationship with them at risk later when you’ve lost your assets and bitterly regret ever having signed on the dotted line.
Before You Sign
Consider whether you really do need to give a PG in the circumstances. Most financial experts advise strongly against giving such assurances (and I would agree with these experts). The harsh reality is that if the business fails, or payments cannot be made for other reasons, you stand to lose your home and you may still be responsible as a guarantor after the business has been dissolved, or after you leave the business or resign as a director.
For a lesson in why you shouldn’t give a PG if you can avoid doing so, Google Lloyd’s Names, or simply follow this link: #mce_temp_url#