By David Powell
One of the main benefits of operating your business as a limited liability company is to protect you personally: a company exists as a separate legal entity. As such, the company enters into contracts in its own name (rather than you having to sign on the dotted line yourself as the business owner) and, if something were to go wrong, then any claims would be properly made against the company instead of the business owner(s). Why then, when seeking loan funding for your business, is it highly likely that a lender will ask you as the business owner/director to provide a ‘personal guarantee’?
When you provide a personal guarantee, you allow a lender to pursue you personally if the business can’t repay its loan. Depending on the loan agreement signed by your business, and the guarantee signed by you, this can mean different things but you might have given the lender permission to take assets that you own, such as your family home or car. Furthermore it is also likely that the lender will be entitled to take legal action against you, which would damage your personal credit and could make it difficult to borrow in the future, not to mention make it more difficult for you to find employment, buy insurances or rent a place to live.
When businesses borrow money, particularly start-up and SME businesses, lenders more often than not require a personal guarantee from the business owner or other key individuals in the business. Ideally, the business would borrow on its own without involving anybody’s personal assets, but sometimes that’s not an option. Lenders always evaluate borrowers to predict whether or not they’ll repay and for a start-up or young business that has limited information to provide, particularly if it has not borrowed before, it is too risky for lenders because the business probably doesn’t have a credit history of its own.
When lenders can’t make a decision based on the business’ historical information, they may still lend albeit at an extremely high interest rate. In order to reduce the risk to the lender, and therefore achieve a lower interest rate, borrowers will be required to offer the lender sufficient security. Such security may include a legal charge over the business property, a debenture over all of the other assets of the business or a personal guarantee by the business owner.
A personal guarantee allows a business to borrow by the business owner putting his or her personal finances on the line and even if the business is incorporated to limit personal liability, the business owners who provide a guarantee become personally tied to the loan. Lenders want to be able to recoup their money no matter what happens to your business and quite often with new businesses they will ask the question: why should they take a risk if you as a business owner are not willing to put skin in the game.
Often, providing a personal guarantee is the only means of obtaining a business loan. It is therefore important you understand that such a guarantee will pierce the veil of limited liability of having incorporated and that you seek early advice as to how your new found liability can be managed.
For further information, please contact firstname.lastname@example.org
For further details about our expertise in this area, please Click Here