Personal guarantees: What are they and how do they work?

When you apply for a business loan, or any other form of finance, you expect your business to grow and be able to comfortably afford the repayments. But things don’t always go to plan, which is why a lender may ask for a personal guarantee if they believe there’s a risk that your business may not be able to repay its debt in full.

This could be if your business doesn’t have an extensive trading history or a record of making repayments on-time, or if your business operates in an unpredictable industry, for example.

A personal guarantee, also known as a director’s guarantee, acts as a form of security for lenders because, if your business is unable to repay the money it has borrowed, you promise to personally repay the loan yourself.

While there are benefits to providing a personal guarantee, it’s important to consider the implications this could have for your personal finances.

How does a personal guarantee work?

When business owners or directors provide a personal guarantee on a finance agreement, they are agreeing to repay the debt themselves if the business defaults on the payments or becomes insolvent.

A personal guarantee is a legally binding contract that minimises the risk to the lender as there’s more chance that they will get their money back.

Because of this, providing a personal guarantee could increase your chances of getting approved for business finance and may also help you to borrow a larger sum and access more competitive rates.

If your business has two or more directors, lenders may ask for multiple personal guarantees so you would all be liable for the debt.

Without a personal guarantee, lenders can’t usually ask the directors of a limited company (or partners in a limited liability partnership) to repay any of their business’ debts, as the business is regarded as a legally separate entity.

What does a personal guarantee include?

The exact terms of a personal guarantee vary between individual contracts, so it’s important to be aware of the specific conditions before signing anything.

For example, some lenders may ask for the full loan amount (plus interest and any other charges) as a guarantee, which is known as an unlimited guarantee. Meanwhile, other lenders may only require you to guarantee a proportion of the debt, which is known as a limited guarantee.

And, while some personal guarantees won’t affect your home, others may include your main residence and any other assets as security.

It may be possible to negotiate the terms of a personal guarantee with the lender before signing.

How long does a personal guarantee last?

There isn’t a set time limit on a personal guarantee as this will vary between agreements.

For some, the personal guarantee may apply for the full term of the loan. However, it may be possible to provide a personal guarantee for a specified period of time, so you’re only personally liable for the debt for a proportion of the loan term.

Check your individual agreement to see how long a personal guarantee lasts so you know when your liability ends.

Bear in mind that, if you’re liable for the debt, a creditor has to take action within a certain timeframe, known as a limitation period. This is usually six years from the default. After this period, a creditor may not be able to start a claim or enforce the guarantee.

Does a personal guarantee affect your credit score?

If you provide a personal guarantee, the lender is likely to check your personal credit history. This check may appear on your credit file but, as long as your business repays the loan and the lender doesn’t enforce the personal guarantee, your personal credit score shouldn’t be affected.

If your business defaults on the loan and your personal guarantee is called in, this will be recorded on your personal credit report. Failing to repay this as agreed could have serious consequences for your personal credit score and could even result in a debt relief order (DRO) or bankruptcy, for example.

Can I get out of a personal guarantee?

If the personal guarantee is in writing and signed, it is legally binding and the lender can enforce it. This means you have to meet the terms of the guarantee and repay the loan as agreed.

The only way you may be able to get out of a personal guarantee is if there were any loopholes in the agreement or if there were any problems that could make the guarantee invalid. This could be if you weren’t made aware of all the terms when signing the contract, for example.

It may be worth checking if there’s a clause in the guarantee (or if you can add one before signing) that releases you from the agreement if you leave the company, for example.

If you think there’s a reason why your personal guarantee shouldn’t be enforced, get professional advice as soon as possible.

What to consider before signing a personal guarantee

Before signing a personal guarantee, it’s important to understand the terms and conditions and what the implications could be for you. If there’s anything that isn’t clear or could be ambiguous, make sure you clarify this with the lender and ask for independent advice.

Some of the points you need to consider are:

• What does the guarantee include? Does it only apply to a particular agreement (such as a loan), or does it cover any finance you take out from that provider, including overdrafts or borrowing more on a new or existing loan, for example? Make sure you check if your personal assets, such as your home, are included in the guarantee or not.
• Can you negotiate the terms of the guarantee? It may be possible to discuss the terms of the guarantee with the lender and reduce your personal liability, for example. More established businesses with a good trading history and credit score will be in a stronger position to negotiate. It may be worth enlisting the services of a legal professional to negotiate on your behalf.
• How long is the guarantee valid for? Does it last until the end of the loan term or a section of the term?
• When would the lender enforce the personal guarantee? What would be classed as a default and what process would the lender follow to enforce it? Would you receive any notice or would the lender demand payment from you immediately? How would you need to repay the money owed?
• What requirements do you need to satisfy in order to be released from the guarantee? Make sure it’s clear how and when the personal guarantee ends, so you don’t get any unexpected surprises in the future.
• Have you looked at any alternative sources of funding that don’t require a personal guarantee? These could include a secured loan, specialist types of finance such as invoice finance or asset finance, or business grants, for example.

If you decide to go ahead with a personal guarantee, make sure you fully understand the implications for your personal situation. It’s worth thinking about what you would do in case you are required to fulfil the terms of the guarantee.

You may also want to consider taking out personal guarantee insurance, which could cover the cost of some of the personal guarantee.

Ultimately, it’s a good idea to seek professional financial and legal advice before agreeing to a personal guarantee to help you understand the terms of the agreement and, if necessary, negotiate with the lender.