Your business: understanding the implications of signing surety for business debt

John was the owner of a successful picture framing business built up over many years. Like most entrepreneurs, John needed external funding to start up his venture, and signed surety for a bank loan to help his business grow. Unfortunately, John did not put any protective measures in place to secure his debt, and when he passed away unexpectedly, his business not only had to be closed down, but his executor had to repay the loan from his estate, leaving his family in dire financial straits.

“Signing surety without surety is the biggest financial risk many business owners take. We see cases like this every day, which are easily avoided if owners take steps to put adequate risk cover – in the form of what is called contingent liability insurance – in place,” says Jannie Rossouw, head of Sanlam Business Market.

Rossouw says very few business owners realise that if they sign surety on behalf of their business, their personal estates may also be affected, with unintended financial consequences for loved ones if they should die or become permanently disabled.

He says the implications of signing surety on behalf of a business do not stop at the estate of the deceased owner – there is a ripple effect that could potentially ruin a thriving business. The following may happen:

• The bank may call up the surety exposing the estate of the owner
• If the surety is called up against the deceased estate, it will result in a claim against the business, which may require the remaining owners to pay in the shortfall
• Long-term and short-term funding structures may be exposed – third-party creditors may withdraw finance or may increase the cost of finance.

So what is contingent liability insurance? It usually takes the form of an insurance policy with life and disability cover that the business takes out on the life of the business owner for an amount equal to the amount for which the owner had stood surety.

The business owner enters into an agreement with the business to force the business to use the proceeds of the policy in the event of a claim to pay the liability for which the business owner had stood surety. This is backed up by a cession of the policy to the bank or other funding institution for security.

“Of all the financial planning needs entrepreneurs should consider, contingent liability is by far the most important. Covering other insurance needs first is like putting the horse before the cart. Almost all businesses have debt, and yet our statistics show that less than a quarter of the business insurance policies we sell are for contingent liability,” says Rossouw.

He says it is crucial to obtain expert financial advice from a qualified financial adviser before making any decisions on business insurance cover. “A financial adviser can assist business owners to prioritise their business insurance needs to protect not only the business, but also themselves and their families,” he concludes.