By Todd Davison, director of Purbeck Insurance Services
Few small businesses have the financial resilience to cope with late payment, a point made very clear by the Chancellor at a round table on the issue in July, revealing it is the cause of 50,000 small business failures each year.
A Purbeck study amongst the owners and directors of SMEs support the Chancellor's findings. Close to a third of SMEs are experiencing increasing problems around late payment, managing cashflow and access to finance. Late payment impacts cashflow and poor cashflow can kill businesses. When you have a business loan in place, the risks become greater.
There are steps small firms can take to reduce the risks associated with securing new finance, particularly where a personal guarantee is involved. In fact we're seeing an increasing number of new firms taking advantage of personal guarantee insurance - 20% of applications for personal guarantee insurance from Purbeck currently come from the directors and owners of start-ups.
Accessing finance, whether to start up, to sustain or to grow a business, is part and parcel of being a director or owner of a small firm but this can be a major challenge for smaller businesses deemed to be a bigger risk to traditional lenders. Often the only way to secure funding is by providing a personal guarantee.
Taking a personal guarantee to secure a loan is not something most owners and directors of small businesses relish. If things go wrong and a call is made under the guarantee, they and any other guarantors will be liable to pay the company's debt. Their personal assets will potentially be on the line - they could lose their home, their bank account could be frozen, their savings taken to settle the outstanding debt.
The prospects for a business might be fantastic but all sorts of external factors can come into play and wreak havoc with business plans. If the personal assets fail to cover the debt, bankruptcy becomes a reality with longer term ramifications.
However, as an increasing number of small businesses are finding, the risk to personal assets can be mitigated through personal guarantee insurance. This offers protection against the risk that the guarantee is called by a lender and will offset any outstanding obligations called in under a personal guarantee. The level of cover is based on a fixed percentage of the personal guarantee the company director wishes to insure and this is dependent on whether the corresponding finance facility is secured or unsecured.
It is also possible to negotiate the terms of the personal guarantee so that the risk can be shared with other company directors and the amount of the personal guarantee can be reduced.
Fundamentally business directors need to understand exactly what any new finance deal entails, the risks involved and how those risks can be mitigated. While late payment remains the huge challenge it currently is for small businesses, it makes sense to put safeguards in place to protect director guarantors from the personal financial risks they may face if their business fails.
