If you have applied for business finance at any point, chances are someone has asked you for a director’s guarantee. If you asked what’s involved, you may have been quickly reassured that a director’s guarantee is standard practice when requesting a business loan.
This is true, however it’s only half the story. You want to be absolutely sure that you understand your obligations before signing.
Please keep in mind guarantees are legal instruments. You'll need to speak to your lawyer to understand the specifics of how a guarantee would affect you. Make sure you have that conversation before signing the guarantee.
What is a director’s guarantee?
A director’s guarantee means that you, as a director/owner, will be personally liable for the debt if the company fails to meet its obligations under the loan agreement.
Ok, so I’m ‘personally liable’ for the debt. What does that mean?
If your business defaults on the loan, you will need to pay off the loan using your personal savings. If you can’t, the lender may be able to pursue your personal assets—including your home—in order to pay off the debt.
If your business pays off the debt according to the schedule, and doesn’t default on any payments, you may never be affected by the guarantee. However, if the business defaults, you could be in hot water.
Creating a corporate structure—like a small business—is generally for the purpose of limiting your personal liability and allowing the business to operate as a separate entity. Without a director’s guarantee, the lender may not be able to come after your personal assets if the company defaults. Signing a director’s guarantee brings you back into the picture, so be absolutely sure you’re ready for what that entails before you agree to it.
My company has several directors. Would we all have to pay out the defaulting loan equally?
It depends on your agreement. Some guarantees have ‘joint and several’ liability for directors. This means that the lender can pursue all of the directors, some of the directors, or any of them individually for the full amount of the debt. This puts a lot of power in the hands of the lender and can create some sticky situations that you should be aware of beforehand.
- If you are the last director standing, you could be called upon to repay the whole debt; or
- If you have the deepest pockets (i.e. if you’re the wealthiest director), the lender may just go after you because they know you have the capacity to pay.
If you have several directors you should be very clear on the type of liability you’re signing up for, and what your respective levels of risk are in the event of a default.
Why do so many lenders want a guarantee?
Lenders like director’s guarantees for a few reasons:
- They give them another way to get money back if the borrower defaults;
- They indicate that the borrower has ‘skin in the game’ and will be less likely to default because people will go to great lengths to protect their core assets, such as the family home;
- They are easy—guarantees can achieve the above benefits without the bank having to do any financial modelling and without having any real understanding of your business model.
Is there anything else I should look out for when considering a guarantee?
It’s very important to read everything related to the guarantee very closely and consult your lawyer along the way. You may want to ask your lawyer about the following things:
All moneys guarantees
This means that any security or guarantee that you provide will cover all amounts the debtor owes to the creditor under any arrangements (including future arrangements) regardless of how they arise.
Ongoing guarantees
Leaving the company won’t normally free you from your guarantee. Keep an eye out for details of when you’ll be ‘released’ from the guarantee.
Can I get a loan without a director’s guarantee?
The short answer is yes. There are a number of lenders who will offer money without seeking a guarantee. But be aware that these are the exception to the rule, and as with all things in finance, you will normally have to pay more because the lender will consider the deal to be higher risk than the same loan with a director’s guarantee.
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