Personal Guarantees: What they really mean

A decent article on Personal Guarantees (PGs) is long overdue.  It is an area I believe is not explained properly by funders and, with all due respect, is not often understood properly.  I hope, as a business owner, you will commit a couple of minutes to reading this article, to understand why PGs are commonplace, and why they are not as problematic as you might think...

If there is one subject that upsets a business owner in the application process more than any other, it is the request from a lender for a PG.  In the business owner's mind of course, a PG creates a massive, negative, shift in funding viability. The PG immediately changes a "business-only", cold, rational, exclusive decision, into a far more emotional, problematic issue that would probably involve a difficult conversation with a spouse, and an understanding, rightly or wrongly, that the family home and other personal assets would be at risk.  In many, many cases, giving a PG is viewed as a non-starter, and the funding request falls down at that hurdle.

But should this be the case? Is our understanding of PGs accurate in today's marketplace?

My belief is that, due to a lack of understanding, or effective communication from funders about what PGs could mean, this single issue is costing many businesses the very funding that could significantly improve their turnover, profit levels, and overall growth.

Let's look at two crucial facts:

1. Virtually all lenders require them now

It is extremely common to find that a PG is required by virtually all funders today.  But why has this practice become commonplace?

From a lenders point of view, PGs are used as an incentive to prevent Directors closing a limited company down without paying back the funding.  There have obviously been precedents over the years.

Sadly this has come about due to a few unscrupulous companies who have no intention of paying back funding.  They simply close down and start up again.  Lenders without a PG have no legal recourse to directors to get their funds back.  If you were to ask most lenders, they would say that in the vast majority of cases, the only time a PG has ever been acted upon, has been when a company has shut down, the Directors have “vanished", and the lender has chased the Directors personally for the lost funds.

It is also worth noting that in today's environment of "responsible lending"; lenders and credit committees are under enormous pressure from all sections of society, as well as their own investors/shareholders, not to take on loans deemed "too risky".  It's why the world is in the problem we are in the first place.  Not taking a PG increases the risk that, further down the line, funds might not be retrievable.  PGs therefore mitigate the risk for lenders that Directors may intend not to repay the funds.

2. PG's are typically a last resort

PGs can usually be found ranking behind all of the following: the flexibility of the lender to help businesses through any payment problems, then the security itself, then the debenture, and then the company's ability to pay back the debt.

If a loan falls into default, and subject to maintained communication, most lenders will try to be flexible, and help the borrower through a tough period.  It is not in either party’s interest to call in the loan. The lender loses an income stream and the borrower suffers enormously.  Lending works best for both parties when it is continuous, so most lenders will look to be reasonable.

If problems mount, in the vast majority of cases, the security taken when granting the loan (e.g. commercial property, physical goods being traded, invoices) will usually be more than sufficient to pay back the debt.  Lenders do not lend at 100% loan to value, often for this very reason.  In the event of default, or repossession, lower LTVs give everyone leeway should the value of the security drop.

In the highly unlikely event that the value of the security plummets uncontrollably in an apocalypse style scenario, and does not cover the outstanding debt, then the company's ability to pay back the debt through existing cash flow is the next port of call.

However, some lenders do take a view that all aspects of security can be chased simultaneously.  It is therefore important to discuss how a PG ranks with your lender in question, so you can evaluate the risk of working with them.

So, I hope you can see that a series of Domesday scenarios need to happen before a PG is typically acted upon, and company debt needs paying back personally.  The crucial element tends to be the value of the security.  A commercial mortgage at 60% LTV needs to drop more than 40% to become a problem, and in many cases, whatever proceeds are regained by a bank will be enough.  In the issue of stock or physical goods, the value of the stock would need to be minimal, and in that event, the business still has the opportunity to pay out of other business income.

A different perspective may, or may not, be of use!

What I’ve discussed above are a result of my experiences, based on numerous transactions with borrowers, lenders, and solicitors.  Whatever you make of my points, it is important that independent legal advice is sought when considering a PG.

I hope this article has been of benefit in understanding what a PG is likely to mean to a business owner, how it ranks in the scheme of things, and why lenders insist on having them these days.  At the very least, I hope the PG question is asked early in your conversations with lenders. From there you can assess the lender’s view on how the PG ranks, and crucially don't waste precious time continuing discussions should you be unwilling to give one.

It is my hope that, by addressing this issue, some businesses will have a new understanding of PGs, how to assess them in relation to your specific business, and perhaps feel able to look at funding options that could really help to grow the bottom line.

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