Blog: Personal guarantees, are they worth it?
Jamie Davidson is managing director at Edinburgh-based Conduit Finance
Prior to the global financial crisis, access to funding was relatively straight forward and worst case scenarios rarely considered. Banks and specialist lenders would lend in most cases with light due diligence.
Following this downturn, banks have spent years trying to exit SME and residential & commercial real estate transactions, with a glut of non-performing loans being sold onto specialist loan servicing funds to recover the debt.
As a result of this we have seen a seismic shift in the care and attention taken by borrowers when taking on fresh debt or restructuring. Many have had their fingers burnt, or know of someone local to them who has, with the ultimate backstop being the Personal Guarantee they signed.
I expect many didn’t appreciate the extent to which this would impact their personal situation, long after the restructure or Administration.
Borrowers now seem much clearer, and focused, on the personal recourse being requested from new funders. In the boom years borrowers would simply sign the documents so they could get on with the project in hand, without giving too much thought or attention to the potential recourse.
Most guarantees were via joint and several liability of the individual Directors of the business so regardless of each persons net worth they bore a proportionate burden linked to the debt. In recent cases we have seen Directors having to compensate for their do-Directors by contributing more cash or by simply being the focal point of the bank’s enforcement.
A Personal Guarantee is a written, legal promise from an individual to repay any shortfall on a specific loan or account which cannot be met by the principle debtor, normally the Single Purpose Vehicle (SPV) or trading business. As mentioned above, most guarantees require joint and several liabilities, meaning that each individual who signs a guarantee can be held responsible for the whole amount of the debt.
Personal Guarantees aren’t always fully enforced, but can be negotiated to a certain point., a recent example being a £2,000,000 personal guarantee liability being settled for £0 as the Director worked with the lender and delivered an exit of other assets quickly. However your willingness to sign a personal guarantee reflects your commitment to the success of the business or transaction, by putting your personal assets at risk.
When a Personal Guarantee is signed, the signatory becomes personally liable for the loan, even if the business is incorporated with limited liability, or offshore.
As we raise funding for clients we are finding an increasing concern from Directors of borrowing entities to put up personal guarantees to enable transactions to proceed at the lowest possible rate.
This can lead to a stalemate if an amicable middle ground cannot be achieved.
One solution is Personal Guarantee Insurance. It is a fairly new product to the UK market, and is generating some serious interest from our customers. It helps Directors insure against the potential risk the Personal Guarantees would impose if the deal went sour.
Insurance policies are tailored for Directors who are exposed to Personal Guarantees, indemnifying a set proportion of the liability. The insurance will pay out a percentage of the liability under the Personal Guarantee, which is often capped after a certain amount of time to around 90% of the maximum value.
The amount of cover is dependent on the value of the Personal Guarantee given, and the length of time the insurance has been in place. This insurance is used to give the director of new enterprises peace of mind as they progress into success.
Mitigation of risk is a focus for both the lender and the borrower so for the borrower Personal Guarantee insurance is a worthwhile way to access the best pricing without risking the family home.
Brexit has seen a number of lenders withdraw from Scotland recently. These have been lenders backing away from the risk of Scottish independence, as opposed to purely Brexit risk, and returning to geographical areas perceived to be more safe, such as the major cities in England or the south east. The next step would be for lenders who have deployed funding in to Scotland seeking to irritate their agreement with the borrower and call in the loans, a common situation we experienced during the credit crunch.
From a lending perspective where gaps appear lenders soon appear. There may be some local contraction of lending volumes but in the medium term we expect there to be sufficient liquidity available for Scottish SME and Property acquisitions and refinancing. Recently there has been favourable downward pressure on interest margins owing to competitive tension and limited deal flow, this may not continue to edge rates lower but the cost of money is cheap so a levelling off isn’t a barrier to closing deals.