Business 101: How to protect your startup from bankruptcy

You’ve taken the plunge and your small business venture has taken off. You’re confident you’ll defy statistics like 70-80% of South African small businesses failing within the first five years. However, you encounter your first hurdle when applying for a business loan – the bank requires you to sign surety to secure the financing.

Meera Naidoo, Head of Legal Support at SanlamConnect, says it is an industry-wide standard for banks to request a surety before approving a finance application. “A surety is a contractual obligation in which the business owner or shareholder acknowledges that they’re personally liable for the business’ debt if the business is unable to settle this debt This guarantee mitigates risk on behalf of the lender. Without it, if a business were to fail, the bank wouldn’t have leverage to collect the debt.”

Before entering into such agreement, Naidoo says it is critical that business owners understand the possible consequences for them, and for their business.

Understanding the risks of a personal guarantee

Naidoo explains that when business owners or shareholders act as sureties for a business loan, they intertwine their personal estate with the business’ debt, which can be risky. “This means that should the business fail to meet its loan obligations; the bank can call upon the business owner’s assets to settle the outstanding amount.”

The situation can become particularly complex if the surety passes away. “The deceased’s estate will become liable to pay off the debt, leaving the owner’s executor and heirs in a challenging position where they may need to liquidate assets to meet obligations,” says Naidoo.

Business protection through contingent liability

She recommends  that small business owners who secure a loan from a bank that requires a suretyship should  protect their business through a contingent liability policy. “This policy safeguards a business by ensuring that should the person who signed the suretyship face unforeseen circumstances, like death or disability, the loan doesn’t impact their estate or the business’s stability – the bank is repaid, and any excess amounts return to the business.”

Contingent liability policies can be lifesaving for businesses, individuals, and financial institutions by ensuring:

  • The individual’s estate remains separated from the business.
  • The business clears all outstanding debt.
  • The financial institution receives the owed money.

Naidoo emphasises the importance of ensuring that the contingent liability policy is collaterally ceded and not absolutely ceded.  This means the creditor is only entitled to the amount owed to them whereas an absolute cession gives the creditor full right of ownership and rights to the proceeds of the death benefit.  This will ensure that the bank/creditor only becomes entitled to the outstanding debt and does not acquire the right of ownership over the policy.

“Sanlam understands that South Africa’s small businesses have unique challenges, as well as unique needs. That’s why we encourage small business owners to educate themselves on the implications of business loans and to implement appropriate protective measures to safeguard their own financial well-being as well as that of their business,” concludes Naidoo.