Why do businesses have to sign a personal guarantee for a merchant account?

Every merchant account provider will ask that the owner(s) of a business sign a personal guarantee on their application as a requirement to obtain a merchant account for credit card acceptance. Businesses are set up as a a legal entity to protect members of the organization from being liable on the company's behalf. For this reason, many owners are justifiably reluctant to be a personal guarantor. If you are worried about signing a personal guarantee most providers will waive the requirement only if:

1) the company is public

2) the company has adequate financials (usually 2 years of financial history) to satisfy the underwriters risk concerns.

During a 6 month period, Merchant account providers are at risk for every dollar that passes through any merchant account. They face this risk with every product or service that is purchased with a credit card. When underwriters review a merchant application for merchant account providers they create an analysis on the risk associated with the account. The analysis generally includes projected sales, the product/service, company financials, the owners credit, and company financials.Here's a few scenarios to give you a better idea:

Company A creates a new cutting edge type of snowboard for $600.00. They distribute the product internationally and due to basic social media efforts were able to make sales over $100,000 in their first month. Company A calculates that they will be making the same amount of sales if not more on their second month so they spend all of their cash on traditional marketing efforts. A week later, Company A finds the snowboards were defective and they don't have the necessary inventory or cashflow to refund or replace their products. Cardholders have 180 days to dispute any purchase and call their issuing banks to institute a chargeback. Since there is no cash in Company A's account, the merchant account provider will be unsuccessful at debiting Company A's account making the provider financially responsible to refund all of the customers who disputed their purchase. Company B sets up a merchant account, sells all of their goods, receives payment and flees without delivering their goods.

This is a classic example of payments fraud where a personal guarantee is used to prevent fraudulent behaviour.

A merchant can ask for an exception to not sign a personal guarantee, however the end decision lies in the hands of the underwriter and they have no obligation to accept an application if they are concerned about a merchants risk.In a situation where an account is considered higher risk, underwriters will require that there be a rolling reserve or a deposit to be placed on the account.

Any further questions regarding personal guarantees? Leave a comment or call an expert at Kubera.