Start-ups and SMEs looking for sources of funding need to think carefully before signing personal guarantees, according to a leading corporate lawyer.
James Pressley, Corporate and Commercial solicitor from Kirwans law firm, said that many business owners looking to give their company or start-up a financial boost to help deal with the uncertainty around Brexit may be tempted to take on personal guarantees without properly assessing the risk, or whether an alternative funding source might be available.
While personal guarantees can act as a lifeline for obtaining finance, they can result in business owners being pursued through the courts for unpaid debts, should their businesses meet the same fate as that of Jamie Oliver’s restaurants Jamie’s Italian, which lost branches in cities including Liverpool and Manchester in May.
Jamie Oliver is reported to have signed personal guarantees to the bank HSBC and food supplier Brakes, putting his own fortune at risk.
James said: “Personal guarantees are often wrongly portrayed as being the road to financial destruction, but this isn’t necessarily the case.
“Whether they are right for an SME or not depends on the circumstances of each individual business. For some they allow the opportunity to accumulate much-needed supplies or finances at a crucial stage in the business that will ultimately result in financial growth, while for others it could be that different forms of finance would be far more suitable.”
Perhaps surprisingly, given the part it plays in keeping some businesses afloat, research has shown that more than half (55 per cent) of SME business owners don’t actually know what a personal guarantee is.
In fact, according to research by SME loan provider Wirefund, 21 per cent of SME business owners believes it only means that business owners would pay money back on time to the best of their ability.
Furthermore, nearly two thirds (61 per cent) have no idea that personal assets can be clawed back if they default on the loan, believing that only business assets would be affected.
Here James looks at the key points SMEs should consider when thinking about signing a personal guarantee:
1) Personal Guarantees allow lenders to call on your personal assets if you can’t pay back your business loan (plus interest!)
Your personal assets don’t tend to stop at your watch, jewellery or car; we’re also talking about your home and life savings too. When it comes to personal guarantees, anything you own is up for grabs. If you die with a personal guarantee in place, the lender can even take action to recover money and assets from your estate.
2) You may be able to negotiate the amount of the loan that must be guaranteed
There is often an assumption that the lender will want the entire loan to be guaranteed, but that’s not always the case. Ask whether they would be open to you reducing the amount that is guaranteed on a capped liability basis. Alternatively, the personal guarantee could be unlimited, meaning that the lender is guaranteed that they will recover the total amount of their debt, including any legal fees, from you. It is important to note that you will always be liable for interest and the lender’s recovery costs as well, even if you have agreed a cap on liability.
3) One in five companies fold in the first year
If your business is a new start-up, is there a risk that it could be one of them? Risk assess everything to ensure you’re prepared for if things go wrong. A personal guarantee may be an appropriate risk if your business is stable and you have a plan for expansion, but it is unlikely to be appropriate if your business is struggling and you are juggling debt.
4) Personal Guarantee Insurance is now available
A new type of insurance which protects your personal assets should you default on the loan is now available, and is based on what percentage of the Personal Guarantee the owner wants to secure. There are some caveats, however, so be sure to discuss with your insurance broker before going ahead with an agreement.
5) Find out what constitutes a default
At what point will the lender invoke action against you, and what will that action involve? Will they issue a statutory demand which will allow you 21 days to pay up or agree on a new deadline? It is crucial to determine in advance exactly how the situation could look for you should you default on the loan. It is important to remember that, under most personal guarantees, the lender can just proceed directly against you and does not need to take legal action against your business first.
6) You’ll still have to settle if the business becomes insolvent – even if you’re a limited company
This is what the personal liability aspect is all about – reassuring your lender that, even in cases of insolvency, they’ll still be able to recover the debt. So, you won’t benefit from the security usually offered by administration; the word ‘personal’ in guarantees makes it clear that the directors’ own assets will become vulnerable.
7) Find out what the process of enforcing the debt will be
There are a number of ways that the lender can enforce the guarantee, whether through a County Court or High Court Judgement, a Warrant of Execution which bailiffs will deliver, or a Charging Order. Once a charging order has been made, your creditor can apply to the court for an order for sale, to force you to sell your home. Discuss this with the lender so that you understand what exactly is at risk.
8) Check with a solicitor before signing on the dotted line
As with all contracts, the detail with personal guarantees is in the small print. Make sure a solicitor experienced in dealing with this form of lending checks over the document before you sign to ensure there are no nasty surprises hidden within the wording.