Small businesses are increasingly turning to alternative finance options amid rising scrutiny into the over-reliance on personal guarantees for business loans, new insight has revealed.
In December 2023, the FSB (Federation of Small Businesses) lodged a super-complaint with the FCA concerning lending practices, particularly regarding the onerous requirement by many lenders of personal guarantees from individuals to support loans to SMEs.
Wider industry concerns – including from the House of Commons Treasury Committee, LSB (Lending Standards Board), as well as worries from small business owners about this common requirement – are further highlighting the topic.
New insights from Joe Morley, Business Finance Manager at Funding Options by Tide, revealed that many small business owners are not aware of all the financing solutions available to them – beyond traditional loans and credit cards – with many not even aware of what a personal guarantee involves.
A personal guarantee refers to an individual’s promise to repay finance if their business can’t. In other words, if the business can’t repay the debt for whatever reason (liquidation, insolvency, etc.), the business owner/director will be held personally liable.
A personal guarantee of payment minimises the level of risk to the lender by providing an extra layer of protection – in most cases, property is used as the main asset in this guarantee, so homes can be at risk should there be no other way to repay the debt.
Morley said, “Here at Funding Options, we aim to break down funding barriers for our customers. Our process helps business owners to understand their finance eligibility, depending on their specific circumstances and needs, and we empower businesses with certainty through pre-approved offers.
“The platform aims to match business owners with the type of funding that is most appropriate for their needs, not just restricting them to traditional loans.
“Generally, awareness and understanding of personal guarantees amongst our customers is good – however, some of our customers are actively avoiding options which require a personal guarantee (as they want to keep personal/business affairs separate or want no risk against their personal situation) and in some cases they don’t fully understand the implications”.
Personal guarantees can be an attractive option – it could improve your chance of getting finance, it can be less expensive than other funding alternatives, securing finance can be positive, and it allows businesses to reach their potential.
However, before you become a business loan guarantor, you should know the legal basics of the contractual relationship you’re entering, and the prospects and consequences on your personal assets if the personal guarantee is enforced. For example, defaulting on a loan with a personal guarantee can impact your personal credit score.
With the context of this super complaint, Morley added, “According to the FSB, the growing demand for personal guarantees by lenders has detrimental impacts on business owners (including financial and emotional impacts), as well as on the broader UK economy (hindering future business growth via potential decline in credit demand and market distortions).
“Although the majority of alternative loans will still require a personal guarantee there are an increasing number of options now available in the market that don’t – you will find the odd lender in each category (unsecured, asset, MCAs, invoice etc.) that will offer a no-PG option.
“There’s a growing variety of routes to finance available to businesses in the UK, and many are specifically designed to meet the needs of small businesses that are faced with significant financial pressures, and whose directors are struggling to find the credit terms they need.
“There are various types of unsecured funding available to business owners that would rather not put forward their valuable assets as security – including some other unsecured lending options, in some cases involving asset finance, merchant cash advance, and invoice finance.
“As well as consistent demand for standard loan and credit card options, we have seen an increased interest in unsecured and alternative lending options as a result of the current climate.
“In particular, merchant cash advance and revenue-based loans are amongst the fastest growing business loan types we are seeing at the moment – but there is still more to be done to improve customers’ awareness of these. At the other end of the spectrum, we are seeing a decline in the use of overdrafts (outside of banks)”.
