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Guarantee Alternatives to Improve Your Close Rate
If you are providing financing or bonding to small and mid-sized businesses, your firm will likely require personal guarantees from the principals of the client company. For several years prior to the recent recession, credit was easy and it was possible to get deals done without having personal signatures or pledges to back-stop the risk of default ' not today. With rare exception for those businesses with extraordinary financial strength, obtaining credit of almost any type for emerging growth or middle-market businesses, i.e., those from startup through $100 million in sales, will require guarantees by the owners with 20% or more of the equity in a company. At the same time, financing companies are seeing more competitive pressure and a drive to get transactions closed when they find a good client. This logic applies to lease companies, commercial lenders, asset-based lenders, bonding firms and the like.
Developing an Effective Strategy
A competitive strategy to soften the perceived impact to those making the guarantees and to allow your company to mitigate its risk may be one of the keys to winning new business. Developing an effective strategy for structuring and managing the personal guarantee begins with understanding your firm's objectives and perspective. Start by assessing why your firm really needs the guarantee (other than policy dictates). Is it to assure that you lock-in the significant owner of the client company, so he is tied to the business to increase your likelihood of being repaid (especially if things do not go as planned). Or is it a financially weak business, and you are seeking additional collateral or assets; maybe both ' or to eliminate a conflict of interest between multiple businesses with the same owner. There are a number of reasons. The key is to be clear about why.
Next, put yourself in the shoes of the business owner. Determine the maximum out-of-pocket amount that the guarantor will actually pay if everything goes wrong and he must personally write a check to your firm. Knowing this amount may play into the terms and the amount that he might guarantee. Some owners do not mind guaranteeing their company's debt and risks as long as they are never really at risk of loss ' in other words, their worst case out-of-pocket amount is zero. This may sound obvious, but not always intuitive. Simply by showing the numbers or highlighting the real downside risk to the guarantor (vs. the perceived risk), you may bring value and clarity to the transaction that others won't.
One strategy for individual guarantors is to assure that the amount of debt guaranteed never exceeds the liquidation value of the assets of their business, taking into account the priority of liens and repayment if the business went bankrupt. If they are OK with taking some financial risk in addition to the amount that can be covered through liquidation of the business, then calculate the same liquidation value and add the acceptable amount. Once you have helped the guarantor establish a limit, suggest that he have his controller, bookkeeper or accountant provide a monthly or quarterly estimate of liquidation value based on their actual financial statements. This will provide him and you visibility so he can track and manage the risk being taken.
If you are in a position to shape the deal, use the information above when negotiating the terms of the guarantee so they fit the situation and limits. You are helping the client manage his risk and differentiating your deal from others. Below are some of the deal points that you should consider.
1) Guarantee of Payment vs. Guarantee of Collection ' the most common guarantee is that of payment. This typically means that if the client company does not meet the agreed payments, the lender, lessor or bonding company can demand payment directly from the guarantor without pursuing further action against the company. A fallback position to soften the impact for the guarantor is to offer a guarantee of collection. This arrangement typically requires the lender first exhaust its options against the company before it can demand payment from the guarantor. So if the guarantor never borrows more than the liquidation amount of his company's assets and he made a guarantee of collection, he could avoid ever having to write a check from his personal assets. Alternatively, you may negotiate a guarantee that only provides protection in the event of fraud or wrongdoing; this is sometimes referred to as a fiduciary guarantee.
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