A personal guarantee on a merchant account: is a legal promise that a merchant will be personally held responsible to cover any losses inquired on a merchant account. Generally, these losses would occur from a “Customer Chargeback” that went unpaid by the business. In this case, the person signing the personal guarantee would be legally held responsible. This simply means that if a business defaults on a chargeback, the guarantor is held liable. Generally, there is no specific collateral behind a personal guarantee but is a requirement of a merchant approval.
Don’t confuse a Personal Guarantee on a merchant account, with one on a business loan.
Here is an example of the ladder:
What Is A “Personal Guarantee” On A Business Loan
A personal guarantee is basically an added insurance to a creditor that the merchant or business owner is committed to repaying the unpaid financial obligations of the company to the creditor. If a merchant is not willing to sign a personal guarantee then from the perspective of the creditor the merchant does not stand behind the company. In such a case, why should the creditor take the risk?
With a personal guarantee, the lender will have recourse to the business owner in case the business defaults on a loan. This is basically a backup for the lender to make sure that any outstanding debt that the business owes will be paid in case of a default. Even if the company is structured as a limited liability company or corporation, you will still be held personally liable for the company’s business line of credit or loan in case of default if you signed a personal guarantee.
If you are a small business and include the following, then most types of business financing require a personal guarantee:
- SBA loans
- Revolving lines of credit (with some exceptions)
- Invoice factoring
- Online loans
- Traditional bank loans and lines of credit
There is one major confusion regarding the personal guarantee and it is about how it affects the personal credit of the guarantor. When you supply a personal guarantee, it doesn’t mean that the lender will report the financial obligation to the personal credit reports of the business owner. A lot of business owners and merchants think that by signing a personal guarantee the financial obligation will be automatically reported to their personal credit. That’s now how it works. It depends on how the lenders decide to share their payment data.
For instance, although some business credit lines programs require the merchant to sign a personal guarantee, none of the debtor payment activity that the merchant carries on those credit lines report to his personal credit. These specific business credit lines only report to the reporting agencies for business credit.
Who Should Guarantee A Merchant Account
Typically the principal in the business is required to sign it, guaranteeing any losses incurred by unpaid customer chargebacks.
Who Should Guarantee A Business Loan
As a rule of thumb, anyone who owns at least 20% of the business should sign a personal guarantee for a loan. Many loan programs list this as a requirement, particularly those that are targeted toward small businesses. Many online lenders and banks are also following this. Furthermore, if there is more than one individual guaranteeing the loan, it significantly reduces the risk to fulfill the entire guarantee. This is good for both the borrowers and the creditor.
Sometimes the creditor may require the spouse of the business owner to co-sign a personal guarantee. If your business and personal finances are entangled, then it can be appropriate to have your spouse co-sign. However, it is highly recommended that you consult with a lawyer about the potential consequences. Separation or divorce during the period of the loan could negatively impact the loan contract. Apart from this, if you are not a part of the management or executive team of the business, then you should not sign personal guarantee.
How Much Should Be Guaranteed
A personal guarantee used for a business loan does not necessarily guarantee a full loan, particularly if a loan is backed by certain collateral. For example, a creditor may require a personal guarantee of 30% of the loan amount and use the collateral to secure the loan’s remaining percentage. Creditors can have different conditions and requirements depending on the coverage of the personal guarantee, so there is no specific percentage that applies to every guarantor. However, many creditors allow you to negotiate a personal guarantee on a merchant account and if you have shown your creditor that you will successfully pay back the loan, then you will be in a good position to negotiate. This means having a strong team, good financials, and a sound business plan.
As the borrower, signing a personal guarantee will involve risk to you personally. You should expect to lose some money as an entrepreneur, but in order to just guarantee a business loan, you should not risk personal financial ruin. So, it is recommended that you think about whether the loan is worth it. If it is, then consider what you can comfortably and reasonably guarantee. It would also be a good idea to consult with a financial advisor who can help you decide whether you should make the investment and for how much.
Other Considerations When Signing a Personal Guarantee
When signing a personal guarantee, one key factor to consider is the additional fees that you may have to cover. You want to know the extra charges that the creditor may hold you accountable for in case your business defaults on the loan. These charges could include late payment fees, legal fees, accrued interest, etc. These costs will generally be specified in the guarantee agreement. It should go without saying but should carefully read the personal guarantee contract of the creditor/bank. Better yet, have a legal advisor or lawyer take a look at the contract. They will be able to identify any risks or red flags that weren’t apparent to you. Make sure that you are truly comfortable signing the personal guarantee agreement before proceeding.
About The Author
Mark Sands, co-founder of High Risk Merchant Account LLC, an authoritative expert in the high risk merchant account space. Mark has decades of experience in the payment industry & enjoys writing on entrepreneurial related topics.