Why Do Merchant Account Providers Ask For A Personal Guaranty?

By Author: Bryan Johnson 1
Total Articles: 19
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Nearly all merchant account providers will require that a personal guaranty be signed by the owner(s) before approving an account for credit card acceptance. Some owners are justifiably reluctant to sign a personal guaranty, 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:

Widget 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, Widget Company goes out and spends all their cash on an AdWords campaign. Ten days later, Widget finds out that all ...
... the gadgets they sold have a bug and need to be replaced. Widget 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 people who bought those gadgets are going to be unhappy with the response and will call their bank to initiate a chargeback (a formal dispute process). The merchant account provider will in turn try to debit Widget's bank account for the amount being disputed to cover their loss, but there isn't any money. At that point, the merchant account provider is then responsible for coming up with the money to refund all those customers who bought the gadget and filed a dispute with their bank.

This scenario applies not only to physical goods, but also web services, memberships, consulting and every other type of transaction. So when a merchant account underwriter reviews an account, they try to calculate based upon a merchants projected sales, with consideration to the product or service being sold, what the underlying risk is and how much exposure they potentially have if a merchant were, for whatever reason, to not be able to meet their customer obligations. The exposure window is six months (180 days or up to 18 months in special circumstances), which is how long a cardholder technically has to dispute a charge (chargeback). 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 48 hours and then pack it up and skip town without delivering the items or services that were sold. Without a personal guaranty, the business can declare bankruptcy and the owners are shielded from any consequence. In this scenario, the personal guaranty is primarily used as a deterrent to prevent bad behavior. Even newer merchants, that have venture funding, are often asked to sign a personal guaranty. That's primarily because their product or service has no track record which creates a lot of uncertainty.

Merchants can always ask for exceptions and underwriters may or may not provide them. Some underwriters may offer a reserve in place of a personal guaranty or offer to review after 12-24 months of successful processing.
Bryan Johnson is the author of this article on merchant account providers. Find more information relating to , credit card acceptance, and merchant account here.