If you’re looking for a business loan, you may find that the lender asks you to sign a personal or director’s guarantee. These agreements can make it easier to access the finance you need to grow your business, but they involve personal risks as you will be liable to repay the loan if the business can’t.

What is a personal guarantee?

A personal guarantee (sometimes known as a director’s guarantee) is a legally binding agreement between a business lender and a company director or owner.

It means that if the business cannot afford to pay its debts or becomes insolvent, the guarantor will step in and make the necessary repayments. It gives banks, building societies and other lenders peace of mind that they can recoup their loans.

How do personal guarantees work?

If you sign a personal guarantee and the business cannot repay its loan, the lender will expect you to pay off all or part of the remaining debt. 

The guarantees are usually unsecured, which means they're not linked to a specific personal or business asset, such as your home. That means the lender cannot repossess assets, but you will still need to find the cash to repay what’s owed.

Different lenders have different terms and conditions. For instance, some will limit your liability so that you’re only responsible for a portion of the loan, which could be as little as 20%. Others will expect the guarantor to be liable for the full borrowed amount. 

Make sure you compare providers to understand what percentage of the loan you would need to guarantee, and read your paperwork carefully before signing to know how long the guarantee will last. Most last the full length of the loan, but some have a time limit.

While personal guarantees are usually unsecured, the lender will still look at both the business and your personal finances to check that you’re in a position to repay what’s owed.

Can you have multiple guarantees for a business loan?

Sometimes a lender will insist on multiple guarantors, particularly if the loan value is high, the debt is unsecured or in instances where the guarantor may not be able to service the entire debt.

However, it’s critical to understand that multiple guarantors are classed as joint and severally liable. That means that each individual is responsible for the whole debt. 

You might agree to split the outstanding money owed equally between the guarantors, but if one person cannot afford their repayment or refuses to pay, the others will still be responsible for that share.

Who needs a personal guarantee? 

Many lenders require a personal guarantee for unsecured business loans. They may also ask for a personal guarantee for other types of financing, such as invoice finance agreements, asset leasing agreements, property loans and leases, and trade supplies.

Unsecured loans are quicker and easier to arrange than secured ones, so they may be more attractive to smaller companies and start-ups who do not have assets to use as collateral for a secured loan. You may also be able to access higher loans at lower interest rates with a guarantor than you would without one.

However, secured loans tend to have lower interest rates. They also allow you to keep your personal finances separate from the business’s, so they’re worth considering if you have assets that can be used as collateral.

Pros and cons

Pros

• You may have access to financing you might not otherwise be eligible for

• You may be offered a higher loan amount and a lower interest rate

• You can have several guarantors to split the risks

• There’s no need to secure the loan with an asset

Cons

• If the business cannot repay the loan, you have to make repayments personally

• In extreme situations, it could lead to personal bankruptcy

• It could impact your personal finances in terms of other borrowing

• It could impact your credit score if you miss personal payments

Things to consider before signing a personal guarantee

Make sure that you understand the terms of the contract, including how much of the loan you’ll be liable for if the business defaults. You should also seek legal advice before you agree. In fact, many lenders will want proof that you have sought independent legal advice before allowing you to sign a guarantor agreement.

What happens if you default on a personal guarantee?

If you’re called on as a personal guarantor because the business cannot make its repayments, you will be expected to make up the shortfall in line with the terms of your contract. If you don’t have the cash to hand, you must liquidate savings or sell assets to raise funds.

If you default on these payments, your personal finances will be seriously affected.  Ultimately, you could be issued with a Debt Relief Order or bankruptcy. Both mean that you can no longer serve as a director of a company or be involved in its management until the bankruptcy has been discharged. Your credit score will fall, and it will be harder to access financing, including mortgages, credit cards, loans and even phone contracts.

Does a personal guarantee hurt your credit score?

If you agree to be a personal guarantor, it will show up on your credit report. Having the guarantee shouldn’t impact your score, but if the business defaults on its loans and you can’t then afford the repayments, this will have a negative effect. If you fail to repay what’s owed, you could end up with a Debt Relief Order or face bankruptcy, impacting your score for many years.

What is personal guarantee insurance?

A personal guarantee insurance policy protects your personal assets and savings if the business cannot repay its loans. Typically, providers will insure up to 80% of the debt. You’ll need to pay premiums upfront, but it can help ensure that your personal finances are secure. Make sure you shop around before choosing a policy and read the terms and conditions carefully.

Alternatives to personal guarantees 

• Secured business loans: these are secured against a business asset, such as property or equipment

• Government-backed loans: these include start-up loans that charge fixed interest rates

• Investors: for example, angel investors who invest money in exchange for a minority stake in the company

• Grants and public sector funding