What Is a Guarantee in Terms of Business Finance?

A guarantee in terms of business finance can refer to two different legal agreements related to a business loan. The first type of guarantee is a business owner's personal promise to be liable for a business debt, if the business becomes unable to pay the debt. The other type of guarantee is a performance guarantee pledged by a third party for the purpose of securing the completion and financing of a construction project.

Structure

A business finance transaction involves the business entity and a financial institution or lender. The business signs loan commitments obligating the business to repay money to the lender. As additional security for the loan, however, lenders often require guarantees in connection with the transaction. This is especially true if the businesses property or credit history are not as high as they should be. The guarantee involves a third party other than the business and the lender.

Payment Guarantee

A guarantee is a legal obligation to satisfy the payment obligation of another person or entity, if that person defaults on its obligation. In the context of a business finance transaction, a guarantee is a commitment by a third party to repay a loan taken out by the business entity. The lender's right to collect money from the guarantor hinges on the business first defaulting on its obligation to the lender. As long as the business meets all its repayment obligations, the guarantor will have no liablity.

Personal Guarantee

A personal guarantee is a commitment by an individual business owner to be responsible for the business entity's obligations. For example, if a limited-liability company takes out a business loan to construct a new office building or warehouse, the lender may require the owner or owners of the LLC to sign personal guarantees in connection with the construction mortgage loan. If the business entity becomes unable to repay the loan, the lender will then have the right to enforce the loan against each individual owner that signed a personal guarantee. This means each personal guarantor will have to repay the loan out of his personal assets.

Performance Guarantee

Lenders may also require a performance guarantee from the construction company hired by business entity to complete a construction project. A performance guarantee serves a different function than a personal payment guarantee. The performance guarantee is a promise from the builder that the builder will actually complete the project. The builder does not guarantee repayment of the loan, but instead guarantees completion of the collateral that secures the business loan. In the office building example, the construction company will guarantee satisfactory completion of the building so that the bank is comfortable that it will have adequate collateral to secure the business loan.

Considerations

Lenders generally require personal guarantees whenever the business has insufficient credit or revenue history to justify approval of the loan application without a guarantee. New businesses or businesses with a poor performance history generally need personal guarantees to secure loans. As for performance guarantees, lenders generally require the construction company to sign a performance guarantee on any new construction financed by the lender.

References

• "Legal Guide for Starting & Running a Small Business"; Fred Steingold; 2011
• SBA.gov: Small Business Loans