Lenders will often require business people, generally the directors of companies, to provide personal guarantees before lending money to a business. Often a business which is a borrower will also allow the lender to take security (usually in the form of the general security agreement, or GSA), over the assets of the business. It is also not unusual for the lender to require the director of a company which is borrowing money to allow the lender to take security over the director’s family residence. Allowing a lender to take security over your businesses’, or your personal assets and property, or providing a personal guarantee, all mean you and/or your business will be at substantial risk if you don’t repay the money borrowed. This article will analyse the level of risk involved with each type of security/ guarantee.
Security over a Businesses’ Assets
If your business owns substantial valuable assets, such as plant and equipment, that can be sold on to other businesses should you default on your loan, it is possible that a lender will request that you provide security over those assets as a condition precedent to issuing the loan. Although providing any form of security is “risky”, in the sense that if you default the borrower will be able to cease the assets in question, allowing a lender to take security over your business’ assets does not put you at personal risk. In a situation in which the business defaults on the loan, the lender will be entitled to seize the assets of the company and sell them off. If the lender is still owed money following this you will not personally have to make up the difference.
This is not the case if you provide a personal guarantee or provide security over your personal assets (i.e. the family residence).
In a situation where a lender requires you to provide a personal guarantee you are clearly at much greater personal risk. In the circumstances set out above, if you had provided a personal guarantee, you would be personally liable to make up any shortfall in the amount owed to the lender. The lender would therefore be entitled to require you to sell personal assets in order to pay off the loan.
Of course one way to avoid the negative consequences of granting a personal guarantee is to ensure that the vast majority of your assets are owned by your spouse (or de-facto), or put into a discretionary trust. Sophisticated lenders do realise that guarantors may try and take this approach, and there are various ways in which they can try and ensure that a personal guarantee is not devalued by such schemes.
The long and short of it is that providing a personal guarantee puts you at risk of personal bankruptcy.
Security over Personal Assets and Property
Another common way in which a lender will secure a loan is to take out security over your personal asset and property. The most common type of security in this space is a mortgage over the family home. Think very carefully before providing such security. For most Australian’s the family home is the most significant asset they will ever own. By allowing a lender to take security over your family home you are putting yourself in a risky situation. If you default on your loan you could lose your house.
Providing a personal guarantee, or providing security over your personal assets or property, is best avoided if possible. Providing security over your businesses’ assets is more common and doesn’t put your personal savings at risk. Make sure that you speak with a lawyer before agreeing to the granting of any type of security or guarantee. LegalVision’s banking and finance team has a huge amount of experience in this space and would be delighted to assist.