What Is a Personal Guarantee for Property Developers?
What is a personal guarantee and how will it affect you as a property developer? Understand the term and what it means.
A personal guarantee is your legal promise as a business owner to accept responsibility for repaying the loan.
For many UK businesses, the debt and monies associated with the business itself are not considered part of a director’s personal finances. In fact, that’s one of the main benefits of registering as a limited company rather than a sole trader.
However, when it comes to sectors with higher financial risks such as property development, many lenders are uncomfortable with the idea of separate debt that can be written off if a business goes bankrupt.
Instead, these lenders typically ask for a personal guarantee for a development finance loan. You can prove this via evidence of your Net Asset Value, or NAV - the total amount of assets you own.
A personal guarantee is a legal term that defines your obligations around repaying loans given to a business in which you’re a beneficial owner. It means you accept the personal responsibility of taking on the debt if the business is unable to repay it.
However, personal guarantees are not for the full loan amount. They are typically between 10-25% of the total amount and are requested from all shareholders in the business, with debt shared between them (so if you had three shareholders, each would be responsible for one-third of the cost). The LTGDV (Loan to Gross Development Value) is what most impacts the personal guarantee - with higher LTGDV often demanding double the value.
Despite the perceived severity of personal guarantees, lenders don’t generally enforce them as a way to recoup their investment: instead, they are more of a statement - a way to ensure you are as invested in the project as the lender is and cannot simply walk away if your business fails to repay the loan.
Let’s take a closer look at what they mean and how they impact you:
Who has liability in a personal guarantee?
The liability of a personal guarantee is joint and several - if you had business partners who defaulted on them you would have to pay back the full amount rather than the third. Personal guarantees are taken from your NAV which includes property and cash assets - though property assets are actually favoured by lenders due to unreliability of cash and cash flow. This means that your existing property holdings may be at risk under a personal guarantee. So, choose your partners carefully and take the time to look at their track record and how it may impact your personal guarantee.
However, these property holdings generally have to be outside of your main residence. Lenders do not want to lend based on a NAV that includes your residence, as that residence is harder to claim against in the event of failed repayments.
Failing to repay a loan with a personal guarantee
Depending on the types of finance you take out with your business lenders, it's likely that the lender will only enforce personal guarantees as a last resort. They are meant to align shareholders and act as reassurance rather than being used as a threat. In the event of failed repayments, most lenders won’t immediately begin trying to enforce the guarantee and will instead consider other options.
In property development, failing to repay your loan is usually due to delays in development or property price fluctuation - so lenders tend to have enough experience to help you through these difficulties so they can recoup their investment once the development is completed.
Rather than enforce the personal agreement they may, for example, offer you the contingency built into your loan agreement as a first resolution. Once that contingency is spent, you may be able to request more money depending on what the leverage limit is. After this occurs, you may need to use liquid assets to fulfil your shortfall or be faced with personal guarantee enforcement.
Bankruptcy and personal guarantees
A lender can force you into bankruptcy if you are unable to repay your loan by obtaining a CCJ against you - but you must owe more than £5000. Going into bankruptcy means a trustee will control your personal assets and will attempt to use them for creditor returns
In forcing you into bankruptcy, the lender is trying to recoup at least some of their investment. Once you are declared bankrupt, however, you become exempt from the debt and can no longer be pursued by the creditor.
Some insurances are available to protect you when entering into a personal guarantee, but the most important thing to bear in mind is knowledge: you should know what agreements you’re entering into and how your shareholders will manage their side of the personal guarantee.
How long does a personal guarantee last?
Your personal guarantee lasts as long as it states in the agreement you make with your lender. It does not automatically cease when certain events take place such as if a shareholder was to leave the business - the personal guarantee still applies to them. That’s why being invested in the success of the development project is an important factor when considering personal guarantees - the lender wants to ensure a shareholder can’t just leave and be absolved of debt.
How to reduce your personal guarantee amount
By making the right decisions you can lower your personal guarantee exposure and therefore limit the potential impact of one being enforced. The best way to do this is by increasing your loan’s contingency - which is typically 5% of the build cost, so you can ensure you have funds to finish your development and make a profit to pay back your loan.
An LTGDV of 50% of below may be excluded from personal guarantees. You can also put cash deposits against either the loan itself or against the personal guarantee.
If you are already in a position where your lender is coming for your personal guarantee, you need to seek legal advice.
Ultimately, however, the best way to negotiate personal guarantees in property development is to work with a funding partner who can explain your obligations, minimise your risk and secure the best funding options possible. Our expert team of brokers at Rangewell can help at no cost to you - so get in touch today to discuss our wide range of property development finance options.