Business loan security, what’s involved?

With any business loan, lenders will require a form of security to mitigate their risk. This security can come in different forms, including personal guarantees, first charges and debentures. Each type of security has its own implications for both the borrower and the lender. Let's explore what’s involved so you can make an informed decision on the right type of security for you and your business.

Personal guarantee

A personal guarantee is a commitment by the business director(s) to repay the loan if the business itself is unable to make the repayments. Although there is no specific charge on the director or their assets, it essentially means that, even if the business is no longer able to make the loan payments, the lender will still receive the funds back from the director. A personal guarantee is still required on an unsecured loan, it’s the minimum form of security a lender will require.

Key points:

• Risk to guarantor: The guarantor's personal assets are at risk if the business defaults on the loan
• Encourages repayment: Knowing their personal assets are at stake, business owners may be more diligent in ensuring timely repayments
• Common for SMEs:Personal guarantees are frequently used for small and medium-sized enterprises (SMEs) where the business might not have substantial assets
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First charge

A first charge is a form of secured lending where the lender has the first claim over a specific asset owned by the business or director if the business defaults on the loan. This means that in the event of liquidation, the lender with the first charge is paid before any other creditors.

Key Points:

• Priority in repayment: The lender with the first charge gets priority over the asset in question, ensuring they are the first to be repaid
• Asset-specific: Typically applies to significant assets like property or machinery
• Lower interest rates: Often results in lower interest rates due to reduced risk for the lender
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Debenture

A debenture is a comprehensive security agreement that can include all or most of the company’s assets. It provides the lender with a floating charge over the company’s assets, which can form into a fixed charge if the company defaults.

Key Points:

• Comprehensive security: Covers a wide range of assets, including tangible assets (property, machinery) and intangible assets (intellectual property, receivables)
• Floating charge: Assets can be sold, replaced, or changed without needing lender approval until default occurs, at which point the floating charge crystallizes into a fixed charge
• Flexibility for business: Offers businesses the flexibility to continue operating normally without constant oversight from the lender
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Choosing the Right Type of Security

The choice of security type depends on various factors, including the size of the loan, the nature of the business, the assets available, and the risk profile of both the lender and the borrower.

Understanding the different types of security on a business loan is crucial for both lenders and borrowers. Personal guarantees, first charges and debentures each offer unique benefits and risks. By carefully considering these options, businesses can secure the necessary funding while managing risk effectively, and lenders can protect their investments. It’s important to understand the implications involved with taking a business loan, and only borrow funds that you can afford to repay.

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