Small and midsize enterprises (SMEs) must understand how personal guarantees could potentially heighten their risks to bankruptcy, according to an expert.
Jirsch Sutherland partner and bankruptcy trustee Malcolm Howell said as common as personal guarantees are, they are often referred to as “kryptonite” for business owners.
“The use of personal borrowings and mortgage guarantees for business borrowings increases household and individual financial vulnerabilities — they have the potential to bring you down financially and ruin your financial freedom,” he said.
A personal guarantee, also known as a director’s guarantee, provides lenders and credit providers a written notice by a director to accept liability for a business’s debt.
When a business defaults, the director’s assets such as home, car, and funds in personal accounts could be used to settle the outstanding debt.
“I’ve seen many SME directors go into bankruptcy because they’ve provided personal guarantees on business debts,” Mr Howell said.
“In the event of a default on a loan, or if the business goes into external administration, if the guarantee holder doesn’t receive sufficient funds, which is often the case, they can pursue the director for the debt owned by the corporate entity.”
To protect business owners, Mr Howell said it is crucial to seek advice on the appropriate type of structure, particularly on personal assets and jointly held assets.
On top of this, business owners must review the fine print, ensuring the extent of the personal guarantee being offered.
Another option is to negotiate and amend any document to limit their exposure to corporate debt.
Small businesses dip into personal savings
According to a recent report from Xero, over a quarter of small businesses in Australia had to access their personal savings to keep their businesses afloat.
Of those who accessed their personal savings, a third have been unable to pay themselves, with Xero surveying 526 small business owners.
Xero executive general manager Leigh O’Neill said the uncertainty in the current economic climate is resulting in major issues in the cash flow of many small businesses.
“Planning and forecasting tools are a great way to identify cash shortages and consider all options, whether that's drawing down on a line of credit or increasing your prices,” she said.
These issues lead to many business owners worrying about their personal and business financial future, with less than half saying they feel on track to achieve their goals.
“The stress of managing cash flow is having a detrimental impact on small business owners, affecting their livelihoods and happiness,” Ms O’Neill said.
“That’s why it’s never been more important to plan, forecast, and have a strong contingency plan in place to weather the storm and to support their positive wellbeing.”