Nicshe Business and Accounting Solutions presents surety agreements and what you need to know:
Our team at Nicshe Business and Accounting solutions are often asked by our clients to explain how surety agreements actually work. We therefore decided to put this short article together to highlight some of the key points you need to note when entering into one of these contracts. One of the challenges of being in business is to secure funding for your business as well as being able to secure credit terms with a supplier. Cash flow is an important consideration for all businesses but more so for the small business owner who is perceived to be high risk and as a result has difficulty in accessing credit facilities. Small businesses are dependent on these credit facilities and will often, without thinking or consideration, sign a surety agreement without really reading the fine print, to secure the facility.
At Nicshe, we always advise our clients to carefully read and understand the contents of a surety agreement before signing it. There is a misconception that you cannot change the terms of a surety agreement and that in order to secure the credit facility, you have to accept and sign the terms as dictated by the creditor. In some situations this may well be the case, however generally our experience has been that the supplier will consider changes.
So let us first explain exactly what signing personal surety means. In a nutshell, it means that the bank or the creditor can legally attach your personal property such as your home or vehicles if your business defaults on its loan obligation.
A surety agreement usually only invokes once the Principal debtor (the business) has defaulted. However a surety agreement often includes a clause requiring the surety to sign as co-principal debtor. Signing as a co-principal debtor enables the lender to demand payment in full from each signatory who has signed as surety when the risk of recovering the loan increases or when the business defaults. Business owners who sign as sureties need to be aware that they can remove this section of the surety agreement as the intention of a surety is merely to be the backup to the business and not for the surety to become the principal debtor.
Another important aspect for business owners to be aware of is that they should only sign surety in relation to their shareholding in their business. For example, if the business owner owns only 20% of the business and is looking to take out a loan of R1 million from a financial institution, he shouldn’t stand surety for more than R200 000.
Limiting the time frame of a surety agreement is critical. Business owners with existing loans who decide to take out another loan may unintentionally sign unlimited surety on the second loan. This unlimited surety may be used to cover the first loan as well.
A further unintended consequence of an unlimited surety could be that if you signed surety with a supplier, but then later closed your company after paying up your debts and opened a new company in a different location, you might be held responsible for any other debt you incurred subsequently with that supplier, even if you hadn’t signed surety again with them. To guard against this, we suggest that business owners create a file to store all their agreements signed for credit or finance.
As a final recommendation to manage their risk, we always advise our clients to take out some form of insurance to cover in the eventuality that the business may not be able to meet its obligations under a credit or loan agreement.
If you liked this article and would like to know more about how our firm can help your business with all its accounting and business management needs, please do not hesitate to contact one of our consultants today!