Warning to SME's using their homes as a "guarantee" for business loans
Falling residential property prices with worse to come poses a serious threat to small business owners who have used their homes for a business loan guarantee.
Australian small business owners have continued to use their homes as a guarantee in recent years, but with property values declining across the country and bank interest rates on the rise, Jirsch Sutherland, a specialist insolvency and business recovery practice, is warning SMBs of the dangers that may lay ahead.
Recent reports reveal that house prices have fallen at their fastest rate in more than six years, with analysts declaring that the ‘worst is yet to come’.
Trent Devine (pictured below), a Partner with Jirsch Sutherland, believes that while boom-fueled increase in home equity has allowed many businesses to remain afloat in the past, the current drop in property values may now spell disaster for small business owners.
“Any business that has used personal finances for business borrowings is at risk,” he said.
“As property prices continue to fall, there is reduced levels of equity with which to finance or prop up a business”.
Devine says that borrowing from home equity to start a business is extremely common, especially among husband and wife businesses.
“In the past, when times were tough, struggling businesses have been able to lean on the equity of their home. Now, with falling house prices and other factors, this can have a disastrous knock on effect for businesses.”
He adds the potential for business insolvency often stems from an ill-advised link between business and household finances – a situation he says is nonetheless unavoidable for many new businesses.
“SMBs often use the same bank for the business that they use for personal banking, therefore they’re likely cross-collateralised,” he explains. “They may have their mortgage and business loan with the same bank. They don’t separate one from the other.
“Rises in interest rates and resulting mortgage stress can certainly flow onto businesses as we’ve witnessed over the past 12 months. If a business is struggling, banks might now note that there’s now no property to support that business because the mortgage is under stress. Clearly, this means that business insolvency becomes a strong possibility.”
Devine strongly advises for business owners to treat home and business finances as separate entities to reduce risk.
“Use different banks for business and personal uses so that cross-collateralisation is not an issue,” Devine advises. “If you are utilising personal funds, perhaps a secured loan to the business rather than opting for a capital injection might also be an option.
“Also, business owners who are looking to refinance to help fund their business’s cash flow might find this difficult because of falling house prices.
“When first setting up a business money can be incredibly tight, but it’s important for business owners to take the time and speak to their accountant or adviser to get the most appropriate advice. Options do exist and it’s important to explore them or risk losing everything.”