We are often asked why an invoice finance company would need directors to sign personal guarantees in support of a facility. After all, the whole reason for having a limited company is to protect the directors / shareholders from personal liability – isn’t it?
Well, yes and no.
We would argue that giving a personal guarantee in support of an invoice finance facility is much safer than giving one for an overdraft. The funding formula for invoice finance (a percentage of debts) should ensure that the invoice finance company’s prime security (the debts) always covers the exposure. In terms of overdrafts, it is likely that this type of facility would always be at its highest following a poor period of trading, meaning the sales ledger could be low in value and, therefore, recourse to a director’s personal guarantee would be a likely resolution.
The reason why invoice finance companies like to have a personal guarantee is that it keeps directors “on side” when problems occur (eg when there is a dispute and the customer refuses to pay an invoice which has been factored or discounted). They essentially lend money against pieces of paper!
There are two reasons an invoice would not be paid:
The customer cannot pay – due to their own cash flow position.
The customer will not pay – ie there is a dispute
The first instance can be safeguarded by taking out credit protection on the customer – this can either be from utilising the invoice finance company’s own policy (on which they will charge a premium for the protection) or by purchasing a stand-alone policy.
The second instance can be tricky to resolve if the director/s have no personal interest in resolving the dispute (ie they have already received say 85% of the funds in respect of the invoice).
The other consideration is that, before entering into a factoring / invoice discounting agreement, the business owner has already made the decision to take a risk by offering credit terms to its customers. The directors / shareholders have usually taken such a decision as the business is profitable and will enhance shareholder value. It is not, therefore, appropriate for the funder to step in and take over the greater part of such a risk – unless they are to be offered a shareholding (which is highly unlikely).
When trading on credit terms, business owners need to assess creditworthiness of their customers at the outset and, particularly if they have a significant proportion of their sales ledger outstanding to only a few customer, should consider a credit protection policy.
Disputed debts can best be mitigated by ensuring terms and conditions are transparent and that invoices state clearly what the credit terms are.
It is usually acceptable for any personal guarantee to be limited to a particular value (for instance 20% of the overall funding limit. Invoice finance companies do not like to rely on personal guarantees as it can damage them reputationally – but having one does help “share the pain” when the going get s tough!
If you need any advice on personal guarantees or warranties then please get in touch.
