Should you bet the house on it?
The words of the late Bob Hope still ring true: “A bank is a place that will lend you money if you can prove that you don’t need it”. Business owners are increasingly under pressure to put up their family home as security to borrow. But there are other options.
Banks are asking for increasingly “harmful levels of collateral in return for finance” to small- and medium-sized-businesses, research carried out by the Forum of Private Business concluded in June of this year.
Ever-tougher credit scoring systems with applications for funding by small businesses have become the norm. The criteria that these applications are judged by include a prior credit history, a track record of running a profitable business, and a willingness to invest their own money in the business, says James Hawkeswood, partner at Blake Morgan. “If any of these is not met, inevitably, some form of security is likely to be asked for; in many instances this will be the family home. In an uncertain economic climate, the potential for repossession is very real.”
Before putting up your home as collateral for a loan, consider the alternatives. Business assets, such as IP, stock or premises, could be given as security instead, Hawkeswood advises. “Personal assets, for example, personal savings or an inheritance, might also be enough.”
If your own assets are lacking, someone else may be willing to assist you financially, he adds. A family member, or even a trade supplier or customer keen to see your business succeed could help, although bear in mind the strains that may result if you are unable to meet planned repayments.
A venture capitalist or an angel investor could be another option. However, their involvement will usually come with a say in your business’ decisions, as well as, importantly, equity in your business. “Ask yourself whether you would be willing to give up a stake in your company in return for their money,” Hawkeswood says.
In any case banks’ attitude to financing SME growth is unlikely to change in the short-term; from their perspective such businesses remains a risky investment. A personal guarantee (PG) is, thus, a common way to borrow, despite trumping the limited liability that protects a company’s directors or shareholders, putting a guarantor’s own assets on the line. Indeed, most successful entrepreneurs are characterised by their willingness to take such a gamble: backing themselves and reaping the rewards for doing so.
However, Hawkeswood is quick to point out that this should not mean that you should not try to minimise such risks, and you should always consider the following:
- Check whether the PG is secured or unsecured. Although the latter is preferable, if the bank uses your home as collateral, it will be a secured loan.
- Make sure your obligations under the PG are limited. Are you comfortable with your exposure under the loan? It is important to understand what that means for you, and take suitable professional advice on this.
- Monitor the situation. Check the terms to see whether it may be possible for you to ask for the PG to be released if your business picks up.
- Consider at the outset what happens if you were to terminate the PG. Would the bank pull its funding? If there are multiple guarantors, what would happen if one wants to terminate?
- If your home is owned jointly by a spouse or partner, bear in mind that that person will need to be separately advised before consenting to a PG over the family home.
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