Regardless of the type of debt finance you choose, lenders will need to secure collateral on the money you are borrowing.
This gives them an insurance that should you be unable to repay the loan, they have alternative ways of getting their money back.
Lenders may take the security against assets held by the business, or against the business owner(s)’ individual assets.
Below, we’ve broken down the different approaches to personal liability in more detail:
Fixed and floating charge
A charge is an asset pledged to guarantee the repayment of a loan. This gives a lender the legal right to access the pledged asset and take possession if the business goes into liquidation.
What is the difference between a fixed and floating charge?
A fixed charge is a lien on a specific fixed-asset (such as land, property, equipment or vehicle) to secure the repayment of a loan. In this arrangement the asset is signed over to the creditor and the borrower would need the lender's permission to sell it.
Incorporated organisations need to file the detail of the charges with their registrar. If they are registered as a company, this would be Companies House. Registered Societies and Community Benefit Societies should file with the Financial Conduct Authority. This information is then available by anyone from the registrar, usually on payment of a fee.
A floating charge is a lien on an asset that changes in quantity and/or value from time to time (such as stock), to secure the repayment of a loan. In this arrangement, no charge is registered against the asset and the owner of the asset can deal in it as usual. In the event of liquidation, this floating charge transfers to a fixed charge, making the lender a priority creditor.
A personal guarantee is a type of collateral secured against the personal assets of individual business owner(s). Most lenders demand this sort of guarantee, often in addition to a fixed or floating charge.
The liability of individual members may be limited to the level of guarantee (usually £1) or the level of shares held in your governing document. However, a personal guarantee bypasses this limited liability for the individuals signing up to it.
Personal guarantees are not appropriate for many social businesses if individuals don’t have a stake in the business or make a return. Therefore, it would be unfair to ask them to take on this liability. This type of business should seek a loan provider that does not require personal guarantees.
With a personal guarantee you are risking your money, your house and your personal bankruptcy, so consider it well. Not all lenders demand personal guarantees.
Joint and several liability
'Joint and several liability' is a term used in loan agreements involving two or more borrowers. It gives lenders the freedom to claim the full loan balance from the signatories as a group or from each of them individually.
The lender may sue any signatory who has enough free assets to meet the lender's claim, without taking any action against the others. This could also skew the democratic process in the social business, as those with more assets to lose may demand more of a say. Although not written as such in the governing document, there is a danger that decision making could work like this in practice.
A debenture is a corporate bond backed by the borrower's specific assets. It’s a written, signed, unconditional, and unsecured promise by one party to another committing the maker to pay a specified sum. The lender may require the sum on demand, on a fixed date or on a determinable date.
Debentures have similarities to equity. They can be transferred from one investor to another. They are subordinate to other creditors (except for shareholders). As 'financial securities' they will need to comply with Financial Services and Marketing Act 2000 which can require costly legal advice.
Because they behave like equity but are not, they are of use to companies limited by guarantee that cannot have shareholder equity