Loans can be essential for the growth of small businesses, and as long as they’re managed carefully, they’re entirely positive. Investing for growth is a way that SMEs can lead the economy out of its current stagnation — but there’s a problem.
Banks are increasingly asking directors of small businesses to provide personal guarantees for loans, often putting their homes on the line. The Federation of Small Businesses (FSB) now thinks this has gone too far and has issued a super-complaint to the Financial Conduct Authority (FCA).
Personal Guarantees for Business Loans
When we apply for a personal loan, of course, we are often asked for security — often our home. In the case of a limited company, any security should normally be from the company’s assets, but small businesses may not have suitable assets to provide a guarantee.
In these cases, the lender could ask a director to personally guarantee the loan. This is a risk for the director, of course, but might be considered a low enough risk to be acceptable, especially when the loan is large enough to be transformative for the company.
However, the FSB claims that personal guarantees are now often being demanded by the banks for even small loans. Faced with the risk of losing their home for a trivial amount, directors are increasingly unwilling to provide these guarantees, cutting small firms off from the means to grow.
The FSB’s Super-Complaint
The FSB is asking, on behalf of its members, that the FCA determines the extent of this practice and then asks the Treasury to extend its regulatory perimeter. At the moment, loans to limited companies aren’t covered by the FCA, since they’ve traditionally been seen as low risk.
The arguments put forward by the FSB suggest that this practice is stifling the growth of small businesses by discouraging them from accessing finance. They also point out (though without suggesting that this actually happens) that a default for such a loan would give the lender undue influence over the company’s development.
FSB’s National Chair Martin McTague points out:
“It’s bad news for the individual business — and, zooming out, it’s bad news for the economy as a whole, at a time when we’re looking for economic growth and productivity gains… a strong dose of proportionality is required rather than a blanket imposition of personal guarantees.”
However, David Raw, Managing Director of Commercial Finance at UK Finance, cautions that personal guarantees aren’t bad in themselves, since “The guarantee reduces risk for lenders and therefore Increases the availability of finance that might not be available without a personal guarantee.”
Reducing the Risk of Business Loans
Clearly, the most important aspect of staying safe is to be realistic about your business borrowing and avoid arranging loans you may default on. Of course, not everything can be foreseen, especially in times like these, so if you do need to offer a personal guarantee for a business loan, it might be best to take out insurance for it.
On the other hand, there are sources of finance that don’t involve personal guarantees. As always, however, it’s vital to make sure you’re not falling into the hands of fraudsters. If you belong to a trade or professional organisation, they may be able to advise you about safe options.
The best way of boosting your business’s finances, though, is to ensure you’re being paid fully and on time by your customers. Give me a call if you’re having problems with bad debtors — and you may not need a business loan.