The hidden dangers of guaranteeing a loan

The economic turbulence and changing marketplace in recent times has seen difficult financial circumstances for many small businesses.

When these financial pressures get really intense, unfortunately there can be serious ramifications. One area we have seen this impacting is banks calling in guarantees, something that causes great distress and difficulty.

It's not too hard to imagine how things start off rosy. A son has a great business idea; maybe he is persuaded by a glossy franchise opportunity. He can see a future of being a successful business person, his own boss. His loving parents are just as attracted to the dream, this is the way their son will achieve the success he deserves.

The wheels are set in motion. However the business needs a little bit more capital. The son doesn't quite have enough savings to get things up and running. As everyone can see the dream, mum and dad are easily convinced to help out with the finance by signing a guarantee. They are all lulled into a false sense of security that there is no risk as this business is going to be such a winner.

However, when things go wrong, they go spectacularly wrong. If the business is not a success, the bank will still want its money. The bank will want its money on its terms too. In a recent example we saw of this, the son was keen to repay the loan and may have been able to from a new job over a number of years. However, when the loan went into default the bank had the guarantee from his parents and so were seeking fulfilment of that guarantee for the money that was owed to them. The guarantee doesn't mean mum and dad then have years to pay the amount owed in dribs and drabs. No, it means them having to sell their only asset, their home, to meet their obligations to the bank.

There are a few lessons in this. Firstly, there is the lesson to be wise and considered when thinking about establishing a business particularly if you have to finance that business. Easy to say that in hindsight but if you are risking your or someone else's home you need to be extra careful. You should obtain advice from both your lawyer and your accountant before taking that risk.

The second lesson is that guarantees need to be taken very seriously. Financial environments can change. You need to take off the rose coloured glasses and think carefully about what it means. Talking this through with a lawyer is essential — it's not just ticking the box that you have had independent legal advice but rather having a conversation where you can think and get some advice about whether this is best for you.

If you are thinking about signing a Guarantee for a friend, family member or business venture this cautionary tale reminds us that we need to make sure we have asked all of right questions and have a good understanding of a person's business practices and financial position before we agree to guarantee. If you are concerned when signing a Guarantee ask about your options to limit that Guarantee to a particular amount of money or your ability to have constant updates on a person's financial position. Simply taking a child's word that everything is fine is just not enough.