Limited Companies don’t offer the protection they used to
During the course of a year some 500,000 new businesses are likely to launch in the UK and a large proportion of the budding entrepreneurs behind these businesses will be advised by their professional advisors to run their business through a limited company. These advisers will have in mind that about four of every ten new businesses die within 5 years and that “death” can take the form of an insolvency. The limited company structure has historically meant that in the event of failure at least the entrepreneur’s house and home are not at risk of claims from angry creditors.
However, over the last few years the protection offered by the limited company has been seriously eroded.
The villain of the piece has been the personal guarantee, the “PG” as insolvency professionals like to call it. The concept has been around a long time and in principle is quite simple. A lender or supplier will give credit to a limited company so long as someone (usually a Director) guarantees that is the company doesn’t pay then he or she will pay the debt from their personal resource.
Having spent fifteen years as a business adviser primarily to company directors up to about five years ago personal guarantee issues barely raised their head. They tended to be confined to the main high street lenders who made sparing use of them.
However, over the last five years there have been two major changes. Firstly trade suppliers, notably in construction and contracting are using the personal guarantee as a matter of course.
The entrepreneur with his shiny new company applies to open an account at his supplier of wood/wire/pipe etc and is asked to fill in a new account form that sneaks in a personal guarantee. It is easy to run up £20/£30k buying such supplies and the director suddenly has a large personal debt. Invariably the nature of the guarantee has not been explained – indeed it is often not even mentioned until of course the limited company goes bust.
The second area where the PG has become commonplace is among the non-mainstream lenders, of whom there are hundreds.
New businesses trying to obtain funding from high street lenders struggle: the barriers are huge. They turn to the “secondary” market where loans (at chunky interest rates) are readily available. All that is needed is a directors personal guarantee (oh and one from his wife – possibly also his mother, plus a mortgage on the family home!)
The entrepreneur is full of enthusiasm and in a rush. Independent advice is almost never taken and the majority of guarantors have no real understanding of the consequences if their business fails and the guarantee is called. They sign on the dotted line and take the cash confident they will succeed.
My working life is picking up the pieces for these shell-shocked guarantors where businesses fail.
So, they shouldn’t do it I hear you say? Talking to a very experienced insolvency accountant recently she expressed the view that in fields such as contracting unless you have cash in the bank it is impossible to get up and running without signing at least one PG. My latest client signed six, all of whom now have aggressive solicitors chasing him.
In theory the old advice on limited companies is technically correct. Its just that it doesn’t work like that on the ground where the “PG” is marching forward and entrepreneurs are facing personal exposure.