Personal Guarantees – A Review Of Recent Trends
What is a personal guarantee?
A personal guarantee is a contractual agreement commonly used in commercial transactions, whereby a person agrees to take on the responsibility of repaying a debt or fulfilling other contractual obligations should the primary borrower fail to do so.
In the finance asset industry, lenders have traditionally sought a personal guarantee from a company’s director(s) before agreeing to provide finance to the company borrower.
Personal guarantees provide lenders with additional security by holding an individual’s personal assets liable in the event of a default by the company borrower. This boosts lender confidence and incentivizes the borrower to make payment.
Whilst their use is still prevalent in many lending scenarios, especially those involving large financial exposures or high-risk borrowing, there has been a recent trend reducing the requirement of a personal guarantee.
Why the reduction?
A number of factors including a wish to attract a broader spectrum of borrowers, improved risk assessment and underwriting methods and the changing nature of business relationships are thought to have brought this about.
Some lenders have sought to differentiate themselves from the industry standard by offering lending without personal guarantees in order to attract more borrowers. As a result, other lenders in the same industry have followed suit to remain competitive.
What does it mean for lenders?
The need for a personal guarantee can act as a barrier to borrowers, especially small businesses or individuals with minimal assets. Removing the requirement for a personal guarantee increases the number of eligible borrowers seeking credit.
Conversely, removing the requirement of a personal guarantee may mean lenders deal with more risky borrowers. The company borrower may be more minded to take on risk or prioritise other financial obligations.
What does it mean for borrowers?
The reduction or removal of personal guarantees means there is more available borrowing.
This isn’t always advantageous to a borrower. Lenders will likely take steps to appease their concerns about the removal of personal responsibility which increases the likelihood default and the comfort blanket which provides additional security.
Lenders’ lending criteria may become more stringent and higher interest rates may be applied. Credit may not be as accessible as before and borrowers with proven credit histories may find themselves paying higher rates.
Lenders may also look to alternative lending structures, such as collateral-based arrangements, including buy-back agreements with the asset supplier, or to impose stricter financial clauses. This could make the borrowing process less transparent and more cumbersome.
A reduction in the need for personal guarantees may be seen as making access to credit easier and increasing deal-writing. However, the available options may be less once risk and repayment obligations have been factored in.
Finding the right stance remains a challenge for finance asset companies who continue to strive to strike a balance between safeguarding their interests whilst encouraging responsible borrowing.
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