Lenders must promote personal guarantees to reduce risk

Steve Richardson is a director at Reparo Finance

Survival mode has pretty much ruled the world of borrowing and lending during the past 12 months. Businesses have been encouraged to access emergency finance to fend off pandemic-related failure and lenders have been backed by the government to provide more readily available funds.

Unfortunately, such circumstances have created the opportunity for exploitation. Scrupulous individuals realise the need for quick and accessible money has compromised levels of due diligence.

The Public Accounts Committee has previously warned that Bounce Back Loan Scheme losses associated with insufficient checks could be as much as £26bn.

Estimated losses are likely to be caused by a combination of fraudulent loan applications, as well as lending to companies with little means of repaying borrowing.

While these issues have been widely reported, they aren’t the only due diligence problems caused by the shift to fast cash. There’s also a growing trend of hastiness amongst borrowers, meaning they don’t fully realise the level of risk they are taking on.

Research of more than 200 small to medium enterprises (SMEs) which have taken out external funding in the past 12 months shows almost half (47%) don’t understand what a personal guarantee (PG) is.

Arguably, given this is an individual’s legal agreement they will repay a business loan, it’s the most important part of borrowing money.

A PG should be given as much consideration by a borrower as the loan value, interest rates and repayment amounts. This simply isn’t the case.

Of those SME owners and leaders who don’t understand what a PG is, 18% believe it’s their personal guarantee that their business can honour repayments, whilst 14% think it shows they personally understand the terms and conditions of a loan.

The remaining 12% thought a PG is their guarantee that they’ve provided accurate and true information during the loan application, whilst 3% were unsure what a personal guarantee was and what it involves.

SME borrowers are eager to access funds to protect and grow their companies, which means they aren’t always taking the time to check terms and conditions. This is promoting a lack of knowledge and understanding, which is complicated further by a misperception that limited company status leaves PGs null and void.

A fifth (21%) of SMEs wrongly believe they will be personally protected from their company’s debts because they run a limited company, irrespective of whether they’ve agreed a PG. 11% believe a PG wouldn’t be enforceable should their business become insolvent.

Any of these percentages from the research findings are too high, and 100% of SMEs applying for finance should know exactly what a PG is and what they are agreeing to.

However, the responsibility to fully understand risk doesn’t solely rest with borrowers. Lenders should also be ensuring that loan applicants have full confidence in the financial obligations they are taking on.

This can be made possible by insisting that SMEs take independent legal advice to fully review loan terms and conditions, including personal guarantees, during the loan application.

Admittedly, a lender cannot force a borrower to take legal advice and there is no certainly that their suggestion will result in the applicant consulting an independent lawyer. It will create pause for thought though, which could prove invaluable in a climate of fast cash. The suggestion is enough to provide guidance that could better protect the interests of finance providers, brokers, and other introducers, as well as borrowers.

There’s nothing wrong with quick, more readily available access to finance. These are factors which SME borrowers appreciate and should be encouraged if lending is responsible.

Clear guidance and transparency around personal guarantees are key to this and lenders can play a lead role in driving this to help reduce risk and promote more sustainable business borrowing.