Don’t let personal guarantees lead to bankruptcy: 5 ways to protect yourself

personal guarantees bankruptcy
There are steps to take to avoid a financial fallout. (Source: Bigstock)

Personal guarantees are common, but they can lead to bankruptcy, so franchisors and franchisees need to understand the risks of personal liability on business debts.

Malcolm Howell is a partner and bankruptcy trustee with national insolvency and turnaround solutions specialist Jirsch Sutherland.

“Personal guarantees are commonplace, and with the current economic volatility, more and more lenders and creditor providers are requiring them,” he says. “They’re usually provided for vehicle finance, debtor factoring/invoicing facilities, overdrafts, term loans, and for credit applications for the supply of goods.”

Personal guarantees are Kryptonite

Howell says personal guarantees are also known as a business owner’s Kryptonite.

When a director provides to a lender or credit provider a guarantee to accept a business debt’s liability there are risks involved. If the business defaults, the director’s home, car and any money in their personal account could be used to settle the outstanding debt.

There is no automatic protection if you co-own your home with a spouse or partner because they will also have to sign the guarantee.

“The use of personal borrowings and mortgage guarantees for business borrowings increases household and individual financial vulnerabilities. They have the potential to bring you down financially and ruin your financial freedom,” says Howell.

A significant proportion of personal insolvencies is the result of a failed business, he says.

“I’ve seen many SME directors go into bankruptcy because they’ve provided personal guarantees on business debts. In the event of a default on a loan, or if the business goes into external administration, if the guarantee holder (creditor) doesn’t receive sufficient funds, which is often the case, they can pursue the director for the debt owned by the corporate entity.”

Howell points out the impact of personal guarantees extends to personal debt, such as for cars and personal loans.

Jirsch Sutherland’s 5 tips for protecting your personal exposure

  • If you’re setting up a business or corporate entity, seek advice on the appropriate type of structure.
  • Seek advice on how to structure personal assets and/or jointly held assets.
  • Read the fine print! Review every loan or credit application to understand exactly to what extent the personal guarantee is being offered.
  • Negotiate and amend any document to limit your personal exposure to corporate debt (e.g., to a dollar value).
  • Keep a register and copies of all documents/credit applications that have been signed and that contain personal guarantee clauses.