In the world of business finance, particularly for small and medium-sized enterprises (SMEs) in Australia, securing funding often requires more than just a promising business plan or a solid business performance, they may push for a personal guarantee. Lenders frequently ask for a personal guarantee from the business owners or directors as an added security for the loan. Understanding what a personal guarantee entails and recognising the associated risks is crucial before committing to such an agreement. Here’s an insightful overview provided by an accountant experienced in Australian business finance.
What is a Personal Guarantee?
A personal guarantee is a legal commitment made by an individual, usually the business owner or a director, to repay a business loan personally if the business itself fails to make the repayments. This guarantee essentially bypasses the legal separation that typically exists between a company’s finances and those of its owners or directors. It provides lenders with an additional layer of security, making them more willing to extend credit.
Key Features of Personal Guarantees
– Unlimited vs. Limited: Personal guarantees can be unlimited, where the guarantor is liable for the entire amount of the loan plus any associated costs or limited to a specific amount.
– Secured vs. Unsecured: Some personal guarantees are secured against the guarantor’s personal assets, including property, while others may not require asset backing.
– Several and Joint: If there are multiple guarantors, the terms could stipulate that they are each responsible for a portion (several) or for the whole debt (joint and several).
Risks Involved with Personal Guarantees
1. Personal Financial Risk
The most significant risk of signing a personal guarantee is the potential impact on your personal finances. If the business cannot repay the loan, you could be personally liable for the debt, which might involve selling personal assets to cover the loan amount.
2. Impact on Personal Credit Rating
Failure to fulfill the loan obligations under a personal guarantee can adversely affect your personal credit rating. This can make it more challenging to obtain personal finance in the future, such as mortgages or personal loans.
3. Legal and Financial Complications
If the business defaults and the guarantee is called upon, the guarantor may face legal action from the lender to recover the outstanding debt. This can lead to costly legal expenses and complicated financial negotiations.
4. Relationship Strain
Personal guarantees can also strain relationships, especially if multiple parties are involved or if personal relationships are already intertwined with the business. The stress of potential financial loss can exacerbate tensions within the business and with family members.
Mitigating the Risks
– Seek Legal Advice: Before signing a personal guarantee, it’s essential to obtain independent legal advice to understand fully the terms and implications.
– Negotiate Terms: Try to negotiate the terms of the guarantee, including limiting the scope or amount and specifying conditions under which the guarantee can be called upon.
– Consider Insurance: Some insurance products can cover the liabilities under a personal guarantee, providing an added layer of protection.
– Regularly Review Business Finances: Maintain a close watch on the business’s financial health to anticipate potential cash flow problems before they escalate.
A personal guarantee can be a powerful tool in securing business finance, but it comes with significant risks that should not be taken lightly. Understanding these risks and taking steps to mitigate them is crucial for protecting your personal assets and financial future. Always consult with financial and legal professionals to ensure you make informed decisions about securing finance for your business.
The Team at The Accountants and The Finance Brokers are here to help you navigate your cash flow requirements in your business. We offer complimentary cash flow reviews and assist you in understanding your finance needs.
