How to Navigate a Personal Guarantee When Funding An Acquisition?
How to reduce risk in a personal guarantee?
“I don’t mind the idea of borrowing to buy this company,” a client recently said to me, “But my wife and I both are extremely concerned about our house and her shop if the bank insists on including them in a personal guarantee.”
This is the kind of comment I hear regularly in speaking with individuals working towards purchasing a small-to- medium-sized business.
Since financing the purchase of a business nearly always involves some kind of investment financing or commercial loan, buyers must also contemplate the reality of a personal guarantee. Sometimes the structure of the business in question will provide the corporate veil behind which owners and directors are shielded from personal liability for the company’s obligations. But if not, and if the assets or income of the business itself are insufficient to stand as collateral, the finance provider will ask for a personal guarantee from owners and directors.
The personal guarantee is simply a legal commitment of personal assets in the event that the business cannot meet the obligations of the loan. My clients want to know if anything can be done to mitigate the significant risks of the personal guarantee, understanding full well the peril to their homes and other major assets if the business they buy goes into default.
There is. Personal Guarantee Insurance (PGI) is exactly what it sounds like: a policy covering the potential need for the personal guarantee to be tapped in the event the loan is called in.
PGI is a regulated annual policy available to the directors and partners of limited companies for new or current secured and unsecured loans. Multiple guarantors can be covered on the single policy. Typically, it will cover about 60% of the loan amount and increase to 80% coverage after the first year, though it will usually not cover the entirety of the loan.
The PGI rate is determined according to such factors as the guarantee amount, what assets are also being counted as security, and the overall risk involved. The cost may be as little as £1000 to 15x that. The premium cost can be taken as a company expense.
As with most types of insurance, there are several specified exclusions. These include awareness but no disclosure of potential insolvency and dishonest or fraudulent behaviour, the existence of another policy covering the same guarantee, or failure of principals to follow insurer advice.
While the cost of the PGI will increase the total business purchase figure, it may also help to get a more favourable interest rate when the lender sees that their investments are additionally secured.
The greatest benefit is that it safeguards the wall between corporate and personal which the personal guarantee seeks to break down.
Personal guarantees are legally binding, and are not to be entered into without thought. However, there is nothing mysterious or shady about personal guarantee insurance. It is simply another tool in the belt of the long-sighted business owner, who, incidentally, also wants to sleep well at night.
