SME loans. Endless government task forces, schemes and rhetoric have tried to
reform and improve them with mixed success, but one crucial element has escaped
attention: personal guarantees.
Personal guarantees are agreements where the director of a business is personally
liable for their company’s debt. If the business defaults on the loan, the lender can
go after the director’s personal assets: the house, the car – anything and everything
is on the line.
Why sign such a punitive agreement? Firstly, because there is often no choice.
SMEs need finance but all high-street banks and the vast majority of alternative
lenders require personal guarantees.
Secondly, research we conducted showed that there is broad and deep
misunderstanding of what personal guarantees are and what they entail. A
staggering 55% of British SME owners couldn’t correctly describe a personal
guarantee and 61% were unaware that personal assets were at stake.
In short, personal guarantees are opaque and outdated tools; misunderstood and
misaligned with the needs of British business. It’s time for change.
Do small business owners understand personal guarantees?
We surveyed 510 senior SME decision makers in the UK across various sectors to determine what they knew about personal guarantees. The result: personal guarantees are shockingly misunderstood.
Below is a summary of our findings.
Do SME owners understand personal guarantees?
An alarming 55% of small business owners across the UK did not know what a personal guarantee was. Yet the majority of SMEs have agreed to one.
More than one in five SME owners incorrectly believe that a personal guarantee requires only that the director ‘personally guarantees’ repayments will be made on time, to the best of their ability. 17% believed it meant that the director would guarantee sufficient funds in the business bank account to make repayments and 7% incorrectly thought that business assets would be seized if they defaulted but personal assets would remain untouched.
Reality is far harsher. One leading high-street bank states within its terms and conditions that:
‘any property given as security, which may include your home, may be repossessed if you do not keep up repayments on debts secured on it.’ A far cry from guaranteeing ‘to the best of their ability’.
Question 1: Sometimes a business loan includes something called a personal guarantee. Which of the following, if any, best describes what that means? (Respondents%)
That a business owner/director will personally guarantee the money will be paid on time, to the best of their ability (21%)
That a business owner/director will personally guarantee that if there is enough money in their business bank account, they will use it to pay back the loan (17%)
That if a business owner/director fails to repay the loan, all business assets can be repossessed, but no personal assets will be (7%)
That the bank will be able to repossess the personal assets business owners or directors if the business cannot pay back the loan (45%)
None of the above 10%
Correct answer: d)
79% of respondents stated they had not been put off a business loan because it included a personal guarantee. However, 55% of those SME owners did not understand what a personal
Business owners are not accepting guarantees because they agree with them. They are accepting them simply because they do not know what they are signing up to.
SME owners grasp which assets are liable under personal guarantees?
61% of small business owners surveyed were oblivious that their personal assets were at stake.
This is a staggering number of senior business decision makers to be unaware of the detrimental impact finance can have on their livelihoods.
Question 2: Has your business ever decided against taking out a business loan because it included a personal guarantee? (Respondents%)
Do SME owners realise how pervasive personal guarantees are?
Question 3: What assets do you think are commonly used to guarantee a standard business loan?
However much cash there is in a business bank account (27%)
All assets relating to the business (56%)
Any personal assets belonging to a key person in the business (e.g. house, car) (39%)
Don't know (14%)
Correct answer: c)
Only 8% of the survey’s respondents realised that high street banks always require a personal guarantee to lend to an SME. A combined total of 54% of business owners thought that guarantees were only occasionally, rarely or even never required.
However, the facts paint a very different picture. We looked at the top seven banks in the UK by assets, all of which required a personal guarantee when taking out a loan.
Question 4: When lending to SMEs, how commonly do you think high street banks require someone from the business to put their own assets down as collateral? (Respondents%)
All the time (8%)
Correct answer: e)
These results are extremely concerning. It suggests that potentially millions of SME owners have signed up to a personal guarantee without understanding it. They are completely unware of how truly consequential the terms are, how ubiquitous the agreements have become and the scale of their liability – that the business owners are required to put their personal lives on the line.
What does this mean?
Our research shows that business finance is built on a dangerous, misunderstood practice and a severe underestimation of personal risk among SME owners.
Britain’s entrepreneurs do not understand what the banks are selling them. They do not understand the contracts they are signing and they do not understand the significant risks they are subjecting themselves to.
Looking at just small businesses: there were over five million in the UK in 2015. Using our data this means more than two and a half million business owners potentially secured a loan against their own bricks and mortar without realising it.
Financial institutions are allowing businessmen and women to undertake agreements that they do not understand. This is an unacceptable practice.
It introduces huge risk to the entrepreneur and runs counter to the broader drive in the UK for transparency and the exposure of hidden risk throughout the financial system.
Moreover, personal guarantees were designed for a world where business owners were usually asset owners too. That’s no longer the case.
The average age of a first-time home buyer is now 30 in the UK and 32 in London. The number of under-35s starting business rose by more than 70% between 2006 and 2014, there is a growing mismatch between personal asset and business ownership. Generation entrepreneur is very much generation rent.
Business owners in this position face securing the loans against the assets of others. The personal guarantee buck doesn’t stop with the entrepreneur but is passed on, meaning the homes and
assets of family and friends are on the line, exposed to a misunderstood risk.
Simply put, SME owners are in the dark about personal guarantees and this entails significant risks to business owners and their families.
Can’t we do small business finance without them?
What should we do?
It is possible to operate a small business loan book without resorting to personal guarantees. The finance industry has to do more to support the backbone of our economy without the use of such perilous and costly measures.
Some might argue that the solution is to better educate SMEs about personal guarantees. That
is certainly a welcome step. However, we risk fewer people taking the step of starting a small
business, perceiving the threat as greater than the reward.
Businesses have to be encouraged to try and – in some cases – fail. Some of the UK’s best known entrepreneurs, such as Sir Richard Branson and Peter Jones, failed before they succeeded. If we increase understanding of personal guarantees but leave the system unchallenged it will dampen the entrepreneurial spirit that forms the very foundation of the UK economy.
So what can be done differently?
Firstly, there has to be a change in attitude. Lenders should start from a position of trust, based on thorough understanding of the business at hand. It’s not constructive to assume a default by default.
Secondly, there are smarter ways for lenders to manage risk. At Wirefund, we ask the SMEs who borrow from us to pay us back in small increments on a daily basis. For us, it means 30 days’ of data every month to assess our risk, rather than just 12 repayments per year. A more granular understanding of payment behaviour means we can take an intelligent view of risk without asking for personal guarantees. Any repayment problems can be identi ed and discussed early on.
For business owners, it also makes repayment more manageable – it’s easier to find £50 from a day’s sales than to hold back £1,500 for month end.
Similarly, it can be better for SMEs to take out and repay a number of smaller loans when they need them. There are entrepreneurs out there looking for a loan to pay for another oven for their coffee shop, a cash flow boost to pay corporation tax or a funding injection to expand into a secondary unit. They don’t need hundreds of thousands of pounds. Little and often allows them to manage risk better and does away with the need for a personal guarantee against large debts.
When 55% of business owners don’t know what a personal guarantee is, 61% don’t realise how far-reaching the liabilities are, and only 8% realise how inescapable they are, the conclusion must be that they are not fit for purpose.
At Wirefund, core to our business model is that business owners shouldn’t have to put their financial lives on the line. Even if personal guarantees were better understood, they discourage healthy risk and cheat the country of great businesses.
What’s more, we don’t need them. It’s perfectly possible to operate a loan book without making such audacious demands on British entrepreneurs.
Personal guarantees have passed their use-by date. They are misunderstood and misaligned with the needs of British businesses. It’s time for alternative finance to truly offer an alternative.