How Personal Guarantees make finance cheaper

A personal guarantee (“PG”) is a legally enforceable promise issued by an individual, often a business director or owner, to repay a business debt personally if the company itself fails to do so. Ditch the myth that your business is a distinct entity where SME debt is concerned!

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Where Did Personal Guarantees Come From?

The concept of personal guarantees dates back millennia. During the ancient Mesopotamian and Roman civilizations, the behaviour of one party guaranteeing a debt by another was common practice.

Early suretyship equated to a third party surrendering their property, or in certain cases, their freedom, as security for a lender. Incredibly, the Code of Hammurabi, around 1754 BC, already contains provisions on debt and surety, traced indicatively back to the very ancient, undeniable human necessity for repayment mechanisms.

Forward leap to medieval Europe, and together with the rise of frenetic mercantile law, the tradition continued to develop. The cultural heritage of PGs is therefore entrenched in the history of the law of contracts and the universal need to establish trust in financial dealings.

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Why PGs are Vital for Small and Medium-sized Businesses (SMEs):

Nowadays, personal guarantees are used by most financial institutions when lending to SMEs (and by landlords requiring parents to guarantee their children’s rent at university).

The main reasons for their use in finance is that small businesses don't have many tangible assets or solid credit ratings like larger corporates. SME balance sheets can be slim and their cash inflows unpredictable. In such cases, the business entity carries a much higher underlying risk profile. Accordingly, it's simply harder for lenders to make an educated guess about the probability of repayment.

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The Critical Role of PGs in Risk Reduction and Loan Affordability:

This brings us to the key role that PGs play in reducing risk, thus making credit available and, perhaps most importantly, cheaper.

By acquiring the loan security over personal assets of the owner, the lender enjoys an additional layer of protection. This considerably lessens the perceived risk of default as the owner is now highly motivated to keep the business afloat.

For alternative finance lenders, who serve many of these small businesses who do not qualify for loans from banks, PGs are even more important. The industry thrives on providing fast business loans for entrepreneurs, flexible finance, and with a greater appetite for risk. The PG acts as an important counterweight, allowing for these lenders to lend to a greater number of companies and maintain a sustainable risk-return profile.

The direct consequence of this reduced risk is that loans can be made cheaper too. The lower that a lender's exposure is, the more favourable terms they can offer, such as lower interest rates. Without the personal guarantee, the higher risk involved would necessitate high interest rates, which may render the loans unaffordable or just out of reach for many small firms.

PGs thus seem to be burdensome but facilitate more competitive lending. And they benefit both the lenders and the borrowers.

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Consequences for Business Owners:

For entrepreneurs, giving a PG can impose mental tension, and in times of financial difficulty be a consistent worry. This understandably deters some entrepreneurs from securing necessary financing.  However, taking for read that a PG is an essential part of the lending proposition, entrepreneurs need to be very careful about who they borrow from.  Some lenders, like Swishfund, have a Customer Service Excellence accreditation and will only lend what is affordable. Our collections processes are based on transparency and collaboration.  Enforcement is always the last resort. Other lenders can be less patient and more ruthless in their approach, which is why and it is important for entrepreneurs to know the collections culture of the lender they borrow from.

Despite these very legitimate concerns, the personal guarantee is an essential tool in small business lending. It bridges that most crucial gap between the inherent risk of lending to small or asset-light businesses and the lender's need for protection.

The ideal future might feature more sophisticated models of risk assessment that reduce reliance on personal assets. But we are not there yet. In the meantime, the personal guarantee is the unseen hand that enables hundreds of thousands of small businesses to access the vital capital to create, to innovate, and to power the economy.

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