Personal Guarantees: What you need to know
If you are trying to rapidly grow your business you will, in all likelihood, be looking for some form of external financing. Some investors, particularly institutional investors, may require some form of security to protect their investment in your company.
This is especially true where your company is seeking funding in the case of traditional debt financing from a bank. That security may often take the form of a personal guarantee, so it is important that you are properly informed before entering in to one.
What is a personal guarantee?
A personal guarantee sits alongside an underlying agreement, typically a facility agreement, such as a bank loan your company may take out. It is essentially an undertaking (or promise) given to the lender that, should the company default on its obligations as set out in relevant agreement, you, personally, will fulfil those obligations in the company’s place.
Since the late 1800s companies have been deemed to be separate legal persons from the shareholders who own them and the directors who run them. The main consequence of this is that the liabilities incurred by the company are the company’s and do not pass to the shareholders or directors, except for certain discreet circumstances. Personal guarantees are therefore used to circumvent this limitation to liability so that the lender has greater protection.
When might you have to give one?
Typically, personal guarantees are required in the circumstances where the lender believes your company does not have sufficient assets or other reserves for them to fall back on should the company default on the underlying facility agreement.
Accordingly, whether or not you will have to give one will usually revolve around the size and age of your company. For example, if your company’s financials far dwarf your own to the extent that you have no real way of accommodating for any default, or if the company has a strong financial history, you may not be asked for a personal guarantee. However, if your company is still early in its lifecycle, a personal guarantee may be required.
What else should be considered?
The extent of your liability is wide-ranging. Should the company be in default of the underlying facility agreement for any reason, you are usually liable to cover the extent of such default. In the event that you refuse to pay, or cannot afford to pay, proceedings may be issued against you by the lender. At this point it’s likely a court will give a judgment requiring payment, which can subsequently be enforced against your personal assets, such as your home.
In addition to the security given by the personal guarantee, some institutional investors may also require security over your personal assets. Their reasoning for this is that should the company be in default, they can now go straight to the last step set out above and look to enforce their security against your personal assets without any requirement to first go through the court process.
Consequently, before giving a personal guarantee, you should ensure that you are as informed about the company whose obligations you are guaranteeing as possible. In particular, you will want to have good visibility of the company’s finances and future strategies as well as ideally having some control over them going forward, which you should hopefully have if the company is yours or you’re the majority shareholder.
You need to be aware of the affect a personal guarantee has on the duties of a director. If you’re a director you will be required to declare your interest to the other directors (if there are any) and, depending on the articles of the company, you may be prohibited from voting on certain board decisions. This may cause some corporate governance issues, although there are often steps you can take to deal with this.
Finally, if the company repays the lender who holds the benefit of the personal guarantee before any of the other creditors of the company, a ‘preference’ may be created. In the event that your company subsequently encounters financial difficulties, to the extent that it becomes insolvent, a liquidator may bring misconduct proceedings, known as misfeasance, against you.
When will your liability end?
Generally, the liability created by the personal guarantee will only come to an end once it has been formally released by the lender, which in reality will only be once the company has fully discharged all of their obligations in the underlying agreement.
If you’re being asked to enter into a personal guarantee and are not sure what you’re signing up to, or you would like any further information on personal guarantees more generally, let us help you. You can get in contact with Kirsty Simmonds or you can give us a call on 0345 070 6000.