Accelerator: Keep it legal - Mind what you promise

Take care when giving a personal guarantee for your business's obligations, advises Trevor Watkins.

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Last Updated: 31 Aug 2010

Starting up a business? Looking to expand? Need more space, vehicles or equipment? These are typical situations in which your bank, landlord or finance company may ask you personally to guarantee the commitments of your business.

Under a personal guarantee, you promise to ensure that your business meets its obligations (eg, to repay its loans to the bank) and to make the payments yourself if it defaults. In most cases, you'll be asked for an indemnity too, so even if your business escapes its obligations, you'll remain liable to pay.

What are the key points to watch out for when asked to give a guarantee? First, avoid giving one if possible, particularly if it's to be secured on your home. Suggest other types of security from within the business - say, a charge over its assets.

But if you're not in a position to provide the security for a loan, all may not be lost. If you have a viable business plan and a bank is prepared to provide funding, you may be eligible for DTI assistance under the Small Firms Loan Guarantee Scheme.

If you do decide to go down the personal guarantee route, be sure of what you are agreeing to and try to limit your overall liability. Rather than giving an 'all monies' guarantee, identify the specific debts or obligations covered. And ask for an upper limit on your liability. As your business grows, its cashflow needs may also increase, so that what began as a guarantee of a small sum quickly mushrooms.

Another option is to put a time limit on the life of the guarantee, or specify a notice period and the circumstances in which you will be released. Provision could also be made for the guarantee to be reduced or released when your business's obligations fall below an agreed level. And if you sell up, remember to get your guarantee released as part of the deal.

If fellow directors or partners are also giving guarantees, it's best for each of you to seek to limit your own guarantee obligations to a specific figure or proportion of the overall debt. If you must all be liable for the whole debt or obligation, draw up an agreement between all co-guarantors to indemnify each other if the bank or lender claims disproportionately against an easy target with deep pockets.

Don't allow the bank to consolidate or set off any liabilities arising on other trading accounts. And check that there are no 'negative pledges' in other agreements that stop you from giving the guarantee. Finally, be cautious about providing a guarantee for the obligations of a friend's or associate's business, particularly if you have no control over it.

By giving a guarantee, you're effectively promising to pay all the specified liabilities yourself. So think hard before signing on the dotted line, particularly when putting your home at stake.

Trevor Watkins is a partner at Lewis Silkin LLP (trevor.watkins@lewissilkin.com).

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