The role of guarantees in business funding  // July 28, 2017

guarantees

There are various business funding options that require the borrower to have guarantees in place. This involves a third-party committing to paying any missed repayments that the beneficiary does not make. This is a common clause added to a funding contractual agreement as a way of lenders protecting themselves from any risks.

Guarantees come in two forms:

1)    A pure guarantee ensures that the third party meets their financial obligations. They are legally obliged and responsible to be a guarantor.

2)    A conditional payment guarantee means that they are liable to pay any amounts outstanding.

When would guarantees be used?

The use of guarantees offers extra security to the business funding provider. For an SME with only one director in the company, the lender relies heavily on their ability to pay it back. But with another person or company to back up the loan agreement, there is extra confidence that the lender will recover their funds.

In particular, those companies or directors with a less than perfect repayment record, they may rely on the use of a guarantor in order to secure the funds they need. Every extra guarantee added gives the lender more confidence, especially when guaranteed by individuals or firms with strong credit ratings and reputations.

What about individuals borrowing for business purposes?

There is always the argument that individuals may have better credit ratings and access to finance than small businesses. Instead of business funding, there is the consumer credit option and for directors to pay money into their business and receive dividends – becoming a cash business in the process.

Those with good credit scores can apply for personal loans up to £50,000 at 15.8% APR per year. However, those with less than average credit scores can use guarantor loans to borrow up to £15,000 over 7 years at around 39.9% to 49.9%. (Source: Guarantor Loans)

The consumer guarantor lending sector is worth around £400 million in the UK and the default rate is less than 5%. Those that have guarantees from an individual with a homeowner status significantly maximize their chances of approval. Lenders consider that those with a home should be easier to contact to retrieve funds and be more likely to access finance if they ever needed to make a large repayment.