If you must open a swanky new wine bar in the middle of a rundown industrial estate, the bank is obviously going to be sceptical and want some form of security, usually in the form of a Personal Guarantee (PG). That is the stereotypical use of a PG – to reduce the lender’s risk in a scenario where they cannot otherwise justify it. In the event the business is unable to pay, the lender will seek the full force of debt recovery, seizing personal assets, culminating in bankruptcy for any shortfall. Default and the debt collectors will surely come knocking!
Houdini’s Handcuffs
The thought of placing your home on the line for a business loan can be hard to stomach. For an entrepreneur starting from scratch, a PG may be the only way. The scope for a PG is considerably less when the business has a proven track record or assets in hand. PGs aren’t just for business loans. Sometimes, suppliers will seek a PG from a director where CCJs and poor financials make extending credit hard to justify. Blurring those lines of corporate and personal liability only pays off if the business succeeds.
The activation points of PGs vary. Some will kick in when a repayment is missed, and others will kick in when the business is deemed insolvent by the lender. This can quickly lead to a CCJ, seizure of assets and bankruptcy. Escaping out of a PG is only possible if the lender did not adhere to the rules of engagement; namely providing clear and fair terms, the absence of duress and misrepresentation, and valid signatures obtained with the guarantor being compos mentis (of sound mind). Even then, undoing Houdini’s handcuffs is a roll of the dice. They are notoriously difficult and ironically expensive to contest.
To offset their risk, some guarantors take out insurance. This typically involves a monthly fee to cover up to 80% of their liability. For example, if the business defaulted on a £100k loan, the guarantor would only be on the hook for £20k with the insurer paying out the remaining £80k.
According to the Federation of Small Businesses, PGs are being unnecessarily required by lenders.
Houdini’s Straitjacket
Since 2023, there has been an increase in the number of SMEs backing out of loan applications because of mandatory PGs. Because there is no minimum threshold for requiring a PG, business owners are being asked to guarantee relatively small sums that would be immaterial to the lender in the event of default. It’s not unheard of for a PG to be requested to secure a loan for as little as £1k. With a PG hanging over them, business owners are more risk averse to the point where opportunities to grow may be forfeited for fear of the PG being called in. The FSB has gone so far as to declare PGs a straitjacket on business growth. As the Insolvency Repear’s scythe casts a shadow over work and home, one must question if a PG is worth the personal strain and if the lender can really justify it. In a limited company, a director is afforded a separate legal and financial identity to the business they represent. PGs remove this protection to the point where the guarantor is liable to the same extent as a sole trader.
Houdini’s Alternative
For business owners not prepared to sign a PG, the Enterprise Finance Guarantee (EFG) scheme is worth considering. Launched in 2009 and overseen by the British Business Bank, the EFG encourages lending to SMEs who have been unable to access financing elsewhere. The government acts as a guarantor for up to 75% of the loan amount. Over 40 lenders have signed up to the scheme. Repayments are made to the lender with interest, plus a 2% annual fee paid to the government. Loan terms range from 3 months to 10 years and can be from £1k to £1.2m. For many SMEs, this has negated the need for a PG. Some lenders have come under fire for mis-selling EFG loans, with RBS being the highest profile in 2015. As a result of a ‘misinterpretation’ some SMEs were wrongly told they were only liable for 25% of the loan, or had their existing borrowings incorporated into it.
The Great Super-Complaint
Using powers afforded to it under Section 234C of the Financial Services and Markets Act, the FSB submitted a super-complaint in 2023 to the Financial Conduct Authority (FCA). It is on the basis of PGs being unnecessarily required by lenders for what would normally be unsecured sums or where the security sought is disproportionate to the risk involved. The FSB claims that PGs are bad for business, deterring business owners from applying and, therefore, thriving. It has also called for more transparency about the trigger points of calling in PGs. At a time when the economy needs to see sustained growth, PGs are holding back entrepreneurs. PGs below £25k signed by sole traders fall under the protections offered by the FCA. However, PGs signed by directors are not covered by FCA regulations.
Although the FSB acknowledges it does not have the data to quantify the harm being alleged, the FCA has agreed to collect data from lenders for the period April- June 2024. They have also agreed to review the policies and procedures from a sample of lenders and work with the Financial Ombudsman Service. The FSB has since criticised the data range and sample size, which potentially leaves swathes of its outspoken members in a twilight zone. To shape policy and pass legislation, feedback and testimony from an aggrieved group of individuals is no substitute for cold, hard, industry-wide statistics, which ultimately drive forward the paper trail for real change.
Escapology
Money is the lifeblood of a business flowing from debtor to creditor to supplier, it’s that simple. If the money does not flow, debt collection agencies will happily intervene. The motives behind the rise in PGs is unclear. One could presume that instead of incurring time costs evaluating the merits of relatively small sums, PGs offer quick and convenient solutions without eating into profit margins. One could also presume that because four out of the last five recessions have been amongst the most severe in British history, lenders have become overly risk-averse. Whilst popular in the court of public opinion, the suggestion that lenders are actively seeking to shortcut due diligence and have become skittish is purely anecdotal, although it’s not entirely without merit. The FSB’s super-complaint is based on feedback from its members, and that alone strongly suggests there is substance to be found if the statistics can be obtained. One thing is for sure – the FSB will not let the unnecessary use of PGs disappear into thin air.