Personal Guarantee Risks: What You Need to Know

March 17, 2024

Simon Madziar
Simon Madziar

Minimising Personal Guarantee Risks: Key Considerations

What is a personal guarantee and when is it required?

A personal guarantee is a pledge from an individual guaranteeing that they will repay a loan if the borrower cannot. Lenders typically require personal guarantees when dealing with new or small businesses without established credit histories to reduce their risk.

Whatever point you’re at in the business journey, there’s real value in having a clear funding strategy set up and agreed for your business. The right routes to funding will depend on your business goals, your ability to make repayments and whether your sector is classed as high or low risk. But having a funding strategy in place really is an essential element of your planning.

To fund the growth of your business, you’ll almost certainly need to take out a business loan at some point. But many lenders will ask you to provide a personal guarantee against this business loan – and there’s a risk element to consider when taking out finance.

So, what does offering a personal guarantee on a secured loan actually entail? And what are the principal risks of becoming a guarantor?

Understanding the key risks of a personal guarantee

When you agree to offer a personal guarantee, you’re essentially promising to repay the loan if the business can't make the payments – and to do this out of your own money or assets. This might seem like a small step to take, but giving a personal guarantee can have serious consequences if your business is unable to repay the loan. Understanding the key risks of taking on this personal responsibility, especially for a small business, is crucial as it provides an avenue to access funding that otherwise would not be available.

Here are some of the risks of giving a personal guarantee:

  • Personal liability – by signing a personal guarantee for the loan, you're putting your own personal assets on the line. If your business defaults on the loan, the lender can come after your personal assets to collect the debt. This means your home, car, savings, and other personal assets are all fair game and could be at risk. Additionally, it is important to obtain legal advice from a solicitor before executing a personal guarantee to fully understand your liabilities and potential risks, including your financial position and ability to repay the debt and carefully read and understand the terms of the guarantee.
  • Negative impact on credit score – Pursuing your personal assets by the lender may harm your personal credit rating, making it harder for you to secure credit later. This could label you as a greater risk to lenders, impacting your borrowing capacity, mortgage eligibility, and personal finance options.
  • Strained relationships – Being requested to provide a personal guarantee by a business partner or family member may create tension in both your business and personal connections. Repaying the loan using your own resources can lead to animosity, distrust, and persistent issues with your partner or family member.
  • Difficulty obtaining credit for your business – Providing a personal guarantee for a loan can help the business overcome temporary financial challenges. However, depending on personal loans from directors may hinder your business's future credit options. Lenders view this as risky and may be reluctant to offer credit to business owners, leading to financial difficulties for both the business and the guarantors. This is due to the fact that the guarantor can be held accountable for any outstanding debts if the business fails to repay them.
  • Risk of bankruptcy – Failure to repay the loan by the business may lead the lender to pursue your personal assets, potentially resulting in personal bankruptcy. Bankruptcy can bring about significant long-lasting effects such as challenges in securing credit, asset loss, and harm to your credit rating.

When considering applying for a business loan, it is crucial to evaluate the potential risks. Ensure that you comprehend the associated risks and have a repayment strategy in case the business struggles to meet the loan repayments.

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*Please note that the above information is general advice only. We recommend you seek advice from a specialist relevant to your personal situation. This information is correct at the time of publishing and is subject to change*

Tax laws and regulations can change over time, so it is important to stay informed about any updates or amendments that may affect your tax obligations. The Australian Taxation Office (ATO) is the authoritative source for the most up-to-date information regarding tax requirements and regulations in Australia.

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