Finance May 27, 2021

Using a guarantor for commercial lending

5 min read

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Lots of people have heard of or used a guarantor when buying residential property. Many first homeowners take advantage of the support their parents or grandparents are prepared to provide. Did you know it’s possible to use a guarantor when you’re borrowing for commercial reasons too? The most common will be when a spouse provides a guarantee for their partners business. 

What are third party guarantees and why are they required?

Commercial borrowing policy often requires the individuals involved in the transaction to sign and agree to either a first party guarantee or a third-party guarantee.

A guarantee is an agreement which ensures repayment of a loan or facility. If the business or entity that borrowed the money is unable to repay the debt and accrued interest (in a situation of default) the individual who has offered the guarantee may be required to pay back the outstanding debt. This could be through their own cash or through a forced sale of a pledged asset.

There are 2 main types:

  1. A first party or individual guarantee take place when you are providing security for a loan over an asset which you own.
  2. A third-party guarantee takes place when a person not involved in the borrowing entity (not a borrower, director or shareholder) is offering a guarantee. You might be an owner or part owner of a property that is being pledged as security. The individual involved does not receive any commercial benefit by entering into the agreement however they might be connected to the borrower by way of marriage, or they might be a family member.

Because of the lack of direct commercial or financial benefit to the guarantor, banks take extra caution when working with these individuals. They want ensure they fully understand their obligations under the agreement and also agree the terms free of pressure or duress.

To make sure this is the case, the banks representative must meet with the individual offering the guarantee without the borrower present. The banker will explain the third party guarantee in detail and what might happen if the borrower defaults on the loan. If the guarantor is not comfortable, the banker must not proceed with the transaction. If they are happy to continue, they will likely need to seek further independent advice.

Following this step, Independent legal advice is required to be provided by the clients solicitor and independent financial advice is to be provided by the clients accountant. Whilst this can sometimes be a costly & time consuming process, it there is there is protect both the bank and the guarantor ensuring they are making an informed decision.

Is this overkill?

Most clients say it is. Couples often say, and rightly so, that their assets are shared and whilst the spouse may not directly involved in the business, the income which it generates is shared within their household.

That maybe the case however the unfortunate truth is both businesses and relationships fail, sometimes one leads into the other. Its important that we make informed financial decisions to ensure our long-term financial well being, even if things don’t work out.