Is there still a place for personal guarantees in business finance?

When, on April 21, the Federation of Small Businesses (FSB) put out a statement urging the Financial Conduct Authority (FCA) to provide more protection for small business owners who put their personal assets – typically the house in which they live – up as security for a business loan, they sent a shudder down the spine of a large section of the alternative finance community. Apart from reminding everyone of how, following the financial crisis, the banks called in loans backed by personal guarantees, shutting businesses along the way and taking domestic properties for payments in lieu, it also exposed a serious flaw in the way in which many finance providers have been securing their loans.

Personal guarantees vs business assets

The anti-social aspects of putting families out on the street because of a business debt that has turned bad are plain to see, but is it right that lenders should be more interested in the value of the SME owner’s house than they are in the quality of the company to whom they are lending? Angus Dent, the CEO of ArchOver, certainly sees it that way and refers to this practice as being “indicative of short-cut credit analysis and sloppy lending”; it is the main reason his company has preferred, since inception, to rely on the quality of business assets such as Accounts Receivable for loan security.

Some platforms, such as RateSetter, have been quietly switching their lending policy away from Personal Guarantees towards securing loans against genuine business assets. John Battersby, the company’s Head of Communications, said: “We have stopped taking Personal Guarantees. Our loans are more like hire purchase now, where if, say, a business borrows some money from RateSetter to buy a digger, and if they default on the loan, we repossess the digger – not the business owner’s house.”

More SMEs can now complain to the Financial Services Ombudsman

Under the proposed changes that we know about, it’s already on the cards that 160,000 more SMEs, charities and trusts will be able to take complaints about their treatment to the Financial Ombudsman Service (FOS); these additional businesses are defined as those with fewer than 50 employees, annual turnover below £6.5m and an annual balance sheet below £5m. The FCA has also said that it will extend eligibility to personal guarantors of corporate loans, but, if the FSB has its way, the new measures should go a lot further, starting with a standalone tribunal for small firms.

Asked for their view, Funding Circle, the biggest of them all said: “As a background, we responded to both the FCA and Treasury Select Committee consultations into small business finance and extending access to the FOS.”

“Currently, 90% of the small businesses we have helped to access finance are eligible to go to the FOS. Extending eligibility in the manner proposed in the FCA consultation would result in approximately a further 5% of borrowers being able to use the service (the remaining 5% have turnover of more than £6.5m although we do not differentiate our approach towards these customers – we refer all businesses to the FOS regardless of their size). We are supportive of initiatives that give small businesses a greater voice and are therefore supportive of the proposal to extend the FOS.”

In light of these deliberations, the value of Personal Guarantees going forward has to come into question – it could be said that they are no longer “fit for purpose”, given that it may not be too long before they are rendered worthless as loan security.