What are the risks for a company director signing a personal guarantee?

A limited company has a separate legal entity from its owners. The owner’s personal assets are not usually at risk if the company fails.

At certain points in a company's life, such as its inception or when it needs additional capital to expand, bank lenders or suppliers will look at the viability of the business when deciding whether to lend or supply goods. If they consider that there is an unacceptable risk they will look to the shareholders or directors to provide personal guarantees.

What does that mean for the guarantor?

When a personal guarantee is given by a director it means that that person can become personally liable for the company’s debts if the company cannot meet its obligations. It is vital to make the following considerations before signing a personal guarantee to protect their personal assets.

How can a director can protect themselves from personal guarantee risks?

• Understand the Risks

Many directors sign guarantees without understanding what they are signing or what the implications for themselves are if their company fails. A full risk analysis of future trading is required, looking at possible outcomes and their effects on the company’s viability.

• Are there alternatives?

Rather than taking out credit supported by a personal guarantee, could alternative fund sources be available? It may be worth considering invoice or asset finance, or other secured borrowings.

• Be aware of joint and several liability

If several directors give a personal guarantee jointly and severally, any one of them can be pursued by the creditor for the full outstanding balance if the other directors do not have the assets to cover their share.

• Negotiate the terms

Negotiate the terms of the guarantee with the lender or other creditor. This could include setting a cap on the guarantee to limit potential financial liability. It is important to note that a personal guarantee will continue even if a director no longer has a connection with the company. If a director leaves then they should attempt to release themselves from any personal guarantee at the same time too.

• Conflict of Interest

Guarantee obligations may create conflicts between personal and company interests, influencing decision-making. For example if a bank overdraft is personally guaranteed a director may be tempted to treat the bank preferentially, by not paying creditors so as to keep the overdraft to a minimum, to the detriment of the business and its creditors.

• Personal Guarantee Insurance

Personal Guarantee Insurance (PGI) is a form of business insurance designed to protect business owners and directors who must provide a personal guarantee to the lender when their company takes out a loan. In the event of a company failure this insurance will provide a payout to the director that will cover a portion of the payment needed under the personal guarantee. This is not a cheap option but may produce a solution in certain circumstances.

• Seek Legal advice

Probably the most important thing that a director can do is to obtain legal advice before signing a personal guarantee. This helps to protect directors against the threat of personal liability from the outset, and to understand the risks in more detail.