Having seen a recent spate of requests to provide finance to private companies without the owners of those businesses providing personal guarantees, as they don’t need to with their bank, I thought it was time to put pen to paper and provide some real clarity around this situation.
The vast majority of debt structures with a client’s bank not only include master personal guarantees (signed once and relevant for all future transactions) they also include far more draconian security conditions which take the following forms:-
- Mortgages over real estate
- Fixed and Floating Charges (which really means mortgages) over the actual operating businesses which are now known as a GSA (General Security Agreement). Many companies are blissfully unaware that they have provided these securities and a quick check on ASIC will show whether they exist on their businesses.
- All Monies clauses and Cross Collateralisation clauses essentially wrap up the above securities and tie them to any debt obtained by the company through their bank.
These above styles of securities are a far more powerful and intrusive set of conditions than a simple personal guarantee.
To put this into perspective, where a bank holds such securities, in the event of default the bank has the ability to walk in sell up the properties and seize control of the business as they are simply the mortgagor realising their security position.
Had the financier had simply a personal guarantee from the directors and no other collateralised security, any loss that they incurred on the sale of an asset could only be pursued through the courts as they attempt to make good that loss against those directors.
If you compare those two structures, you will see that the provision of the more draconian bank securities leave the company owners with little ability (if any) to defend against a bank seizing both their properties and businesses, whereas the provision of a personal guarantee creates a downstream liability which can be defended over a longer period while still being in control of the business.
Finally, it is worthwhile making a conceptual comment around the need for personal guarantees.
Understanding financiers are simply providers of debt and not equity partners in the business or venture capitalists, it is entirely reasonable they should look to do all they can to ensure the return of their money and interest when they loan a client $1 million (under present interest-rates they are looking to get that $1million back plus interest of around $150,000).
If a client asks to borrow $1 million for their business it is entirely reasonable for the financier to ask that business owner to be as personally committed to the debt as they are to provide it.
That is exactly what a personal guarantee is doing.
In a world where clients can borrow money at 4% to 5% on equipment, it seems only fair that they are as committed to the debt as the financier is to give it to them.
Having understood all of the above, it is no wonder that many companies finance much of their capital equipment with financiers other than their banks and restrict their own bank’s funding to the core areas of property and working capital.
An incidental benefit to spreading equipment debt across a broader base of financiers minimises concentration risk of debt with one bank and an easier (less expensive) bank migration option in the event of a potential issue with the incumbent bank through an adverse change in manager or bank policy towards an industry.
Put plainly, if a company needs to move banks and they have large equipment debt exposure with that bank, the departing bank will usually insist on the payout of all equipment finance including penalties which amount to around 50% of future unpaid interest on those accounts.
When there are so many excellent alternative financiers in the market, there are good reasons to spread the debt, keep equipment loans away from other core securities and be in a better position to be able to change banks (if needed) without undue cost and pain.