In this article, we’ll explore personal and corporate guarantees, two financial tools that are becoming increasingly popular in today’s market. We will also explain how they can help provide downside protection for lenders. Whether you’re a lender looking for ways to minimize risk or a borrower needing to understand what these guarantees mean for you, this guide will provide more details on the subject.
With a personal guarantee, an individual agrees to be held contractually responsible if a borrower falls behind on repaying a loan. Similarly, a corporate guarantee represents an agreement where a corporate entity agrees to be held responsible.
For lenders, the inclusion of a personal or corporate guarantee helps provide downside protection. In the event the borrower can’t repay the loan, the lender benefits from the added security of being able to recoup all or part of the loan amount from the person or corporate entity who provided the guarantee (known as the “guarantor”).
For borrowers, adding a personal or corporate guarantee to a loan can help reduce the interest rate charged by the lender. A guarantee can also help borrowers become eligible for a loan that they otherwise may not have qualified for, thanks to the extra security provided by the guarantee.
Imagine that a business, Greater Phoenix Real Estate Partners, wants to borrow money to purchase a large commercial building. Alex, who owns 85% of Greater Phoenix Real Estate Partners and serves as CEO, approaches a lender to discuss a loan.
After evaluating several factors, including the commercial real estate that would serve as collateral, the lender offers Greater Phoenix Real Estate Partners a loan with an annual interest rate of 11%. That’s a bit higher than the business was hoping to pay, so Alex asks about providing a personal guarantee. After completing due diligence and confirming that Alex has a substantially large personal net worth (more than $5 million, for example), the lender agrees to lower the interest rate to 9% on the condition that Alex provide a personal guarantee. Alex agrees and the loan is funded.
After six months, Greater Phoenix Real Estate Partners falls behind on repaying its loan. Because of the guarantee, the lender can work to recoup the funds it is owed by pursuing Alex’s personal assets. The exact language of the personal guarantee that Alex initially signed determines how much can be collected.
Many Yieldstreet investment offerings are backed by a personal guarantee from the borrower, oftentimes by the CEO of the borrowing company. The personal guarantee is usually derived from his or her large personal net worth, similar to what we’ve illustrated above.
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