Almost half (47%) of SME owners and shareholders are inadvertently putting themselves at financial risk because they don’t understand loan personal guarantees, according to new research from Reparo Finance.
Agreed during the completion of business borrowing, a Personal Guarantee (PG) is an individual’s legal promise to repay the credit their company has taken on. Despite this, independent research shows 18% of SMEs believe a PG is their personal guarantee that their business can honour repayments, whilst 14% think it’s their guarantee that they personally understand the terms and conditions of a loan.
The research also showed 12% of SMEs thought a PG is their guarantee that they’ve provided accurate and true information during the loan application, whilst 3% were unsure what a personal guarantee was and what it involves.
Knowledge and understanding of loan personal guarantees are further complicated by a misperception that limited company status leaves them null and void. A fifth (21%) of SMEs wrongly believe they will be personally protected from their company’s debts because they run a limited company, irrespective of whether they’ve agreed a PG. 11% believe a PG wouldn’t be enforceable should their business become insolvent.
Steve Richardson, a Director at Reparo Finance, said: “The response to the pandemic and business survival has prioritised quick, available access to borrowing. This may well be detracting from companies paying proper attention to loan terms and conditions, which risks SME owners and shareholders personally taking on financial liabilities they don’t understand.
“Credit terms will not always be limited to the solvency of a company and repayments will still have to be honoured in the eventuality of the company experiencing difficulties. Of course, there are terms to any loan – that’s prudent for all, but it’s really important that SMEs fully understand their exact obligations when agreeing to credit.”
With the research showing 64% of SMEs are likely to take on external finance in the next three years in response to the pandemic, Reparo Finance is urging borrowers to seek independent legal advice during the application process.
Steve Richardson added: “The research highlighted that the clear explanation of loan terms and conditions is a top ranking factor for SMEs when they’re looking at lenders. However, it also showed that a quarter (24%) did not take any independent legal advice to check T&Cs when taking out a loan. This figure is way too high. Borrowers should always draw on legal expertise to check they are comfortable with the financial agreements they are making, and lenders should encourage this – it’s about taking a responsible and sustainable approach to business lending.”
Further research data revealed that 27% of SMEs didn’t think it was worth taking legal advice during a loan application because they didn’t think a PG would be ever be activated, whilst the same number weren’t aware they should consult independent legal experts.
The research was conducted by Sapio Research in April 2021.
204 SMEs, which have taken out external funding for their business in the last 12 months, were surveyed about their attitudes and understanding of business borrowing.