Personal Guarantee vs. Validity Indemnification and Why Do Lenders Request Them?
With a personal guarantee, the lender can go after the signer for any loss, anytime, for any reason – not necessarily because of any fraudulent activity. If the collateral isn’t paying off the loan, the lender can go directly to the guarantor without having to wait to liquidate collateral. With a validity indemnification, if the lender takes a loss as a result of activity relating to fraud or misrepresentation, it turns into a personal guarantee.
As a lender is, in essence, putting money into its client’s business, a guarantee is a show of good faith that the business owner believes in the business as much as the lender does. And the primary reason a lender wants a guarantee is for leverage. If things don’t go well, when a guarantee is in place, the lender knows it will have the owner’s cooperation to liquidate and help get the lender paid out.
At Celtic Capital, our general rule for a personal guarantee is that if someone owns over 20% of a company and is active in the business, he/she should guarantee. There are exceptions, however. If someone owns 40% of the company and has an outside investor (equity partner) who owns 60%, we don’t require guarantees. That’s because we know an equity partner won’t sign a guarantee and when that’s the case, we don’t believe it’s fair to ask the minority owner to provide one.
In cases where we can’t get a guarantee – the business is not privately-owned, nobody owns at least 20%, the business is equity-backed – we’ll get a validity indemnification. Also referred to as a “bad boy guarantee,” a validity indemnification is an agreement to indemnify the lender for any loss as result of one of a list of things that all relate to fraud or major misrepresentation.
Personal guarantees and validity indemnifications, at least for Celtic Capital, are about making sure we have the owners’, and/or senior management’s, cooperation should we need to get out of our loan and not because we’re sue happy. We have no interest in going after guarantors; we’re just looking to come out whole. We’ve had cases where we have come up short, i.e., when equipment didn’t bring in what was anticipated, and we worked with the guarantor/indemnifier to reach a solution that worked for everyone. The goal is to settle in a way where all parties leave the relationship on as good of terms as possible.
About Celtic Capital
Companies looking for working capital to cover operating expenses, fund growth, increase buying power and take advantage of vendor discounts and rebates turn to Celtic Capital. With an appetite for the more complex transactions, Celtic Capital has a history of success in crafting creative, flexible asset based financing solutions from $500,000 to $5 million with no financial covenants.
As an independent lender, working with companies nationwide, Celtic Capital is willing and able to alter price and deal structure and expand lines of credit to handle its clients’ increased revenues; and when cash flow is an issue, will look toward providing an inventory facility to help offset lost cash flow.