The perils of signing a legal guarantee have long been conveyed by an old aphorism, which warns that ‘a guarantor is just a fool with a pen.’ But what was once received wisdom seems to be fading, as one particular brand of guarantor is now growing in number – those who sign up to the pernicious ‘personal guarantee.’

A poll of 500 small businesses by the Investment Management firm Legal & General found that of those with corporate debt, over 35% had directors who had signed personal guarantees. And it seems that lenders seeking this kind of security from directors is becoming increasingly common amongst smaller firms in particular.

So what does a personal guarantee entail and why are they becoming more pervasive? 

Well, a personal guarantee is effectively a promise by a business’ director to make him or herself liable to repay corporate debt in the event of their business defaulting, meaning that they are putting their own assets on the line as collateral for a lender. A personal guarantee is not the only type of security taken against a loan, but can be pursued if the primary security does not cover the amount owed.

The guarantee does not necessarily attach to a director’s home but to their assets more generally. However, as the majority of people’s highest value asset is their house, lenders can act to repossess a guarantor’s property in some circumstances. Such an arrangement is understandably favoured by many traditional lenders who argue that it is the best way of aligning a director’s interests with their own – not to mention a means of further mitigating their risk. In fact many will now not lend to small businesses without personal guarantees being put in place.

But the question of whether it is good business practice for a lender to ‘pierce the corporate veil’ and take security on an individual’s personal assets remains.

I would argue that a company is either robust enough to take on debt or it isn’t, and that using personal guarantees to increase security in fringe cases will never be the answer for lenders.

It goes without saying that they are hated by those who must sign them too, and the reason for this is simple: an individual should not be expected to gamble their home to support their business activities.