• Thomas Troyer CEO

Why do Merchant Account Providers Ask for a Personal Guarantee?

Nearly all merchant account providers will require that a personal guarantee be signed by the owner(s) before approving an account for credit card acceptance. Some owners are justifiably reluctant to sign a personal guarantee. After all, that's one of the main reasons a legal entity was set up in the first place: to protect individuals in the organization from being subject to the company's liabilities. Most providers will waive the requirement if a) the company is public, or b) the organization is a registered 501C3 or 501C4, or c) the company's financials are adequate to satisfy the underwriters' concern about the underlying risk.

So where is the risk? Basically, a merchant account provider is at risk for every dollar that passes through the merchant account during a 6-month period.

Here is a risk scenario: Gidgit Company comes out with a new electronic gadget for $30.00. During their first month, sales are over $100,000 and everyone in the company is ecstatic. To try and build upon the momentum, Gidgit Company decides to spend all their cash on an AdWords campaign. Ten days later, Widget finds out that all the gadgets they sold have a defect and need to be replaced. Gidgit doesn't have the cash to replace them, so they tell customers that they are sorry, they won't be able to honor the 90 warranty that was included. The cardholders who bought those gadgets are going to be unhappy with the response and will call their bank to initiate a charge back (a formal dispute process). The merchant account provider will then unsuccessfully attempt to debit Widget's bank account for the amount being disputed to cover their loss. At that point, the merchant account provider is financially responsible to refund all those customers who bought the gadget and then disputed the charge with their bank.

Merchant account providers face this risk with every product or service sold including services, software, memberships, consulting and anything else that is purchased with a credit card. Therefore, when a merchant account underwriter reviews an account, they try to calculate the risk associated with the account. Their risk analysis will include the merchants projected sales, the product or service being sold, company history, company financials and owner(s) credit. The exposure window for credit card transactions is six months (or up to 18 months in special circumstances), which is how long a cardholder technically has to dispute a charge (charge back). This is also why annual billing and lifetime memberships present underwriting and risk challenges.

The example above is an honest mistake. But merchant account providers are also cognizant of classic merchant account fraud: set up a merchant account, sell a bunch of goods or services, receive the money within 2-3 days and then pack it up and skip town without delivering the items or services that were sold. Without a personal guarantee the business can declare bankruptcy and the owners would be shielded from any consequence. In this scenario, the personal guarantee is primarily used as a deterrent to prevent bad behavior.

Businesses can provide financials to eliminate the personal guarantee requirement. A company's financials need to demonstrate that they have the financial wherewithal to sustain losses that may occur.

Merchants can always ask for exceptions and underwriters may or may not provide them. There are alternative arrangements that underwriters will occasionally propose in place of a personal guarantee such as a rolling reserve or a fixed amount up front.

Merchants need to be very careful with providers that don't maintain the appropriate amount of underwriting due diligence because it will most likely come back to bite them at the worst possible time.

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