The Federation of Small Businesses (FSB) has issued a super-complaint to the Financial Conduct Authority (FCA) to highlight the harsh lending practices of banks that excessively demand personal guarantees for business loans.

Personal guarantees can be a “straitjacket” on business growth, forcing entrepreneurs to put their homes or other assets on the line when taking out finance.

This can be particularly paralysing when they are applied to small loans – leaving many business owners more likely to abandon their business or growth plans or push them into being over-cautious in their decision-making, deterred from making bold choices.

FSB is therefore proposing that the FCA undertake work to assess the extent of this practice, and then consider asking the Treasury to expand its regulatory perimeter to help more small businesses affected, typically limited companies where directors provide personal guarantees.

FSB is a designated consumer body by law and therefore has the ability to send a super-complaint to the FCA when the issue becomes troubling enough for a large number of small firms whose individual complaints may not get the same hearing.

Our super-complaint sets out a number of other ways that overuse of personal guarantees may be damaging small firms, including:

Businesses are put off from proceeding with loan applications, so forgo the capital necessary to grow or are forced to seek out more expensive forms of capital.
In some cases, individuals may give personal guarantees which they then take insurance against – an unnecessary additional expense in cases where the guarantee relates to a loan which is easily affordable for the borrower.
In the event that a small loan backed by a personal guarantee is declared in default, individuals and their families may experience significant distress which is disproportionate to the loss or potential loss which the lender faces.
There is at least the potential for lenders to use the presence of the personal guarantee to gain influence over the decision-making processes of distressed businesses to their own advantage.

Depending on the approach of individual lenders, market distortions in small business lending and the wider economy may arise if certain sectors receive less favourable treatment regarding demands for personal guarantees.

Currently, personal guarantees most often apply to loans taken out by companies which are guaranteed by their directors. This type of lending is not covered by FCA regulations, likely because the concept of limited liability meant the risk of financial detriment to individuals was assumed to be low.

However, the use of personal guarantees has undermined this argument, greatly reducing the kind of risk-taking by business owners that the concept of limited liability was originally developed to encourage.

If the regulatory perimeter is expanded, the FCA should make specific rules for lenders regarding the use of personal guarantees in lending to companies, which balance the interests of borrowers and lenders appropriately.

FSB’s National Chair Martin McTague said: “Put yourself in the shoes of an entrepreneur who’s created a promising business and is keen to grow. You approach your bank for a small loan, but they say you can only have the money if you sign a personal guarantee which would ultimately put your family home or other assets at risk. This is a straitjacket on small business growth.

“It is no wonder that many small business owners in that position are telling us they are choosing to avoid external funding which they could be using to capitalise on new opportunities.

“It’s bad news for the individual business – and, zooming out, it’s bad news for the economy as a whole, at a time when we’re looking for economic growth and productivity gains.

“For amounts which are triflingly small for banks, but potentially transformational for small business owners, a strong dose of proportionality is required rather than a blanket imposition of personal guarantees.

“With interest rates having risen so sharply over the past couple of years, the availability and affordability of new finance for small firms has declined. Adding in personal guarantees on top of higher rates is clamping down on small firms’ appetite and ability to grow and invest.

“Small firms are by definition the ones with the most potential to grow, and to go from start-up to scale-up. The FCA needs to find a balance so that lending is neither overcautious nor reckless, and the sensible steps we have set out in our super-complaint would be a great place to start.”

Responding to FSB’s Super-Complaint to the FCA over SME lending practices Todd Davison, MD of Purbeck Personal Guarantee Insurance says: “Around 45 of firms back off from a finance deal if they find out there is a personal guarantee attached.  Personal guarantees must be proportionate to the loan being advanced and appropriate for each case. We support a full investigation by the Financial Conduct Authority into lending practices and whether personal guarantees are being overused by lenders, particularly in low value loans.”

The latest Purbeck Personal Guarantee Monitor shows that working capital is the top reason for new personal guarantee-backed loans – 47% of applications for personal guarantee insurance (PGI) were for this purpose in Q3 2023.  Furthermore, the main source of funding is unsecured loans, typically provided by alternative lenders – Purbeck saw more applications for PGI in respect of unsecured loans than at any time in the past 6 years, in Q3 2023.

Todd Davison continues: “It is important to recognise that personal guarantees are a core element of the commercial finance market, particularly among alternative lenders.  Therefore, while we want to a proper investigation by the FCA, we feel that any moves to discourage personal guarantees should not lead to lenders either failing or pulling out of the market.  This would reduce choice for small businesses when they are searching for a new loan.

“Education on how to mitigate the risks is also key here and commercial finance brokers been commended in the Government’s Inquiry for the hugely valuable role they play in that process as they work with small businesses to find the right solutions for their needs.  Our research shows that 64% of small business owners would be more likely to sign a personal guarantee if they had insurance in place to protect against the risk of providing it.  Therefore, along with a review of lending practices, we’d like to see greater awareness of the risk mitigation strategies small business owners can consider before they take the big step of signing a personal guarantee.”

Read more:
FSB calls out banks’ use of harsh personal guarantees to regulator