Guaranteed Loans – Meaning, Need, and Importance

Overview

Businesses may encounter situations where they struggle to raise funding, get delayed payments, or need more financial resources which comes across as a hurdle to run and manage a business potentially risking the business viability in the long run. In such times, business entities, especially start-ups and small-scale businesses with access to guaranteed loans could act as a lifeline to afford adequate reassurance of repayments, reduce risk of defaults, and access resources that are not readily available otherwise. Guaranteed Loans in India for businesses are available through bank guarantees, corporate guarantees, or Government guarantee schemes.

Guaranteed Loans – Meaning and Importance

Guaranteed loans are the credit facilities availed from financial institutions/business partners/ vendors or any third party in pursuance of any business function whose repayment is assured by a third party known as a guarantor in the circumstances the debtor is unable to fulfill the debt obligation. The guarantor gives his consent to partially or fully discharge the loan-related liability at the time of entering the agreement itself.

Guaranteed loans are used by businesses with little or inadequate credit history, making way for financially unattractive applicants to be eligible for loans while assuring repayments on time. By minimizing the risk of default, guaranteed loans act as a crucial tool for businesses especially start-ups who are struggling to secure funds through traditional means.

Types of Guaranteed Loans

Bank Guarantee Loans –

Bank guaranteed loans are those loans whose repayment is promised in the event the lender fails to make repayments timely either fully or partially guaranteed by the concerned financial institution. For this reason, bank guarantees on such loans act as a crucial tool for risk management since in the event of failure to repay loans timely the bank assumes the liability for helping a business to access funds or resources even in circumstances which would otherwise be a little more risk.

Corporate Guarantee Loans –

Corporate guarantee loans are whose repayment is assured by a third party known as Corporate Guarantor who consents to discharge the loan obligation in the event the debtor fails to repay loans within the due period. Such a corporate guarantor has a deeper business connection with the borrower (i.e. subsidiary company or business partnership company) potentially reduces risk and builds trust among parties.

Government-Guaranteed Loans –

Government-guaranteed loans are those loan facilities extended by financial institutions where the repayment of the loan is partially or fully guaranteed by the Government. Such government-guaranteed loans offer necessary funding support for various purposes such as seed funding, working capital, and growth operations especially those who cannot avail of credit facilities otherwise or those with poor credit. CGTMSE, MUDRA loans, Stand Up India scheme, MSME loans, Udyogini loans, etc. are some well-known schemes for Government Guarantee loan schemes.

Guaranteed Loans Pros

An Added Layer of Security –

Guaranteed loans come with added security as reassurance for repayment within the due period for the lender and assurance for the borrower which also offers confidence to the lender to approve loans and is even more likely to agree to a higher amount. From the perspective of the borrower, it gives an added sense of security that your loan will be paid even if you struggle to make repayments, hence taking some pressure off both financially and mentally.

Eligibility for Poor Credit History –

Normally financial institutions have certain eligibility criteria for extending credit facilities to businesses. However, security of repayment enables access to unattractive applicants, especially those with little or no credit history. Further, timely repayments by the businesses also boost the credit score.

Access to Business Growth Opportunities –

Prior to offering guaranteed loans, there are thorough processes to scrutinize the financial viability of a business. Therefore, businesses could boost their reputation among investors and creditors by drawing potential business opportunities.

Promotes Trust and Confidence –

Thorough scrutiny of the process offers trust and confidence for lenders to enter into any transaction without any stress or hassle.

Minimized Risk for Creditors –

Government guaranteed loans are especially relevant for minimizing risks for the creditors which enables them to consider applications with higher perceived risks.

Lower Interest Rates –

Again owing to its secure nature, lenders may propose guaranteed loans at lower rates of interest with more flexible terms of repayment.

Guaranteed Loans Cons

Higher Risk for the Guarantor –

Guaranteed loans come with an assurance of repayment from the guarantor either partial or full debt amount which could be a considerable risk for the guarantor. Further, businesses with little credit history, and financially challenged with irregular cash flows could prove to be riskier for the Guarantor.

Choosing a Guarantor can be a daunting task –

As beneficial as it is to have a guarantor in a business loan transaction, however, choosing the right guarantor can be challenging. Businesses seeking a guarantor for guaranteed loans need to be transparent with them regarding their finances and may be required to share data which is not always easy. Sometimes it can get more difficult with someone unaware of the financial difficulties being faced by the business.

Reliance on Guarantor can be risky at times –

Too much reliance on the guarantor to pay your loan repayments if you are unable to. While this is agreed to in your loan contract, when this situation materializes, it can often cause discord between you and your guarantor. Therefore, ensure that the borrower and the guarantor have a strong sense of trust with each other before entering into a guarantor loan arrangement to the best of their relationship.

Lack of Flexibility –

Since the sum of financial guarantees is pre-specified for a certain period which is provided in the contract it cannot be changed later.

Time-Consuming Process –

The Guarantor party may take a while to evaluate the eligibility for the guarantee/guarantee-related conditions concerning the business model, business viability, financial health, etc. making it a longer and time-consuming process.

The Guarantor may also seek Collateral from the Borrower –

Sometimes guarantors may also seek collateral from the borrower to ensure the security of repayment from the borrower which could be as high as the amount guaranteed which may potentially discourage borrowers from seeking guaranteed loans. Such situations may only be positive in the sense that the borrower does not need to liquidate the collateral to receive a guarantee.  Accordingly, the absence of collateral may discourage guarantors from taking the risk in the transaction.

Failure of the Borrower may affect the Guarantor’s Credibility –

Business entities challenging financially and failing to meet repayment dates could have a significant impact on the credit history as well as the credibility of the guarantor in the transaction.

Importance of Guaranteed Loans

Businesses suffer the most in the early years of their establishment. New business owners find it challenging to raise capital, manage suppliers, and get customers, all while making efforts to generate revenue to manage their day-to-day business. Therefore, for new business owners who may be striving to get business loans, guaranteed loans could be a lifesaver.

Enabling Access to Capital –

Guaranteed loans make it easier to access capital for businesses lacking access to funds through normal banking channels. Operating capital, business growth, investment in start-ups, etc., and more which may be valuable for businesses with little credit history.

Increased Chances for Approval –

Businesses such as start-ups and small-scale industries having access to guaranteed loans have higher probabilities of loan approvals as having a guarantor reduces the loan default risks.

Shared Liability –

In pursuance of a guarantee arrangement, the borrower and the guarantor share the liability among them to ensure timely payments to the creditor, which drastically reduces risk and boosts confidence. Further, it can also bring accountability and build financial discipline which could be beneficial in the long term.

Flexible Repayment Terms –

Guaranteed loans have flexible terms of repayment which encourages businesses to operate smoothly and efficiently manage their cash flows.

Available for Multiple Purposes –

Seed funding	Guaranteed loans are available for those businesses in need of developing products or proof of concept, team building, entering of market, validation of the business model, or any other costs for early-stage businesses to take off.
Growth and Expansion	Guaranteed loans offer additional capital that can be used to fuel business growth, expand their business operations, hire a team, updating their technologies for better efficiency, etc.
Working Capital	Guaranteed loans help start-ups and small-scale businesses with capital to run day-to-day expenses including wages, rent, supplies, etc.
Scaling Operations	Guaranteed loans are also available for scaling business for purposes such as capital to launch projects, expanding to newer markets, or investing in new machinery for higher production capacity, etc.

Difference between Limited and Unlimited Guarantee

Limited Guarantee	Unlimited Guarantee
Limited Guarantees are the promises or assurances of repayment under which the guarantor agrees to discharge the debt obligation for a certain capped amount on behalf of the borrower when he fails to repay their debt. Creditors consider it as a form of insurance.	Unlimited Guarantee can be defined as a promise or assurance of fulfilling the debt obligation on behalf of the debtor by a guarantor willingly agreeing to discharge the liability to the extent of his individual assets in case the primary debtor defaults on loan repayments. Unrestricted Guarantees convey a considerable risk element for the Guarantor.
For example, here a business entity has taken a sum of Rs. 2Cr loan and the business owners have consented to a limited guarantee of Rs. 60L. In such cases, the guarantor shall not be indebted to repay more than 60L.	For example, where a business entity has taken a loan of Rs. 5 Cr for the business and the total assets of the business entity are up to Rs. 2Cr. Only, the bank attached his assets to recover the remaining sum.
Limited guarantees are capped to a certain extent and are generally less risky than unlimited guarantees.	Since Unlimited Guarantees are unlimited in extent, they are unreliable than limited guarantees typically allowing the creditor to attach the personal assets of the guarantor if the borrower defaults on the repayment.

Difference between Corporate Guarantee, Bank Guarantee Loans, and Personal Guarantee

	Corporate Guarantee	Bank Guarantee	Personal Guarantee
Meaning	Corporate guarantees are written assurances to be provided by an independent corporate guarantor agreeing to undertake the debt liability in the instances where the original debtor is unable to make payments within the due period.	Bank guarantees imply financial instruments obligating the guarantor bank to undertake the financial obligation for failure on the part of the debtor to fulfill his promises as agreed in pursuance of a contract.	Personal Guarantees are a legal assurance of repayment by the personal guarantor to repay even out of his personal assets in the event the lender fails to make repayments timely.
Parties	The debtor, Creditor, and Corporate Guarantor are the parties in a corporate guarantee transaction.	The primary Debtor, Creditor, and Guarantor Bank are the parties in a typical bank guarantee transaction.	Borrower, Lender, and the Personal Guarantor are the parties in a typical personal guarantee arrangement.
Liability	Where the debtor business fails to fulfill its debt obligation the liability befalls upon the Corporate Guarantor.	Where the debtor fails to repay the loan within time The liability goes to the guarantor bank.	Where the borrower fails to repay the debt obligation within the due period, the liability to repay debt arises upon the personal Guarantor.
Risks Involved	Corporate Guarantees entail more risk elements for the Corporate Guarantor as compared to the debtor to make good the loss for the pre-specified amount.	In a bank guarantee transaction, banks hold a higher degree of risk than the customer.	Personal guarantees carry a higher risk element than conventional guarantees as in the event of failure to repay debt may cost his personal assets.
Applicability	Relevant for business-related transactions.	It could be relevant for business as well as personal transactions.	It could be relevant for business-related as well as personal transactions.

Conclusion

Hence, Guaranteed loans serve an indispensable role in supporting the economy, particularly younger businesses developing and helping to bridge the gap between the financial support and businesses that are not considered by financial institutions. However, the decision to choose the right guarantor should be taken cautiously by evaluating the terms and conditions of the guarantor transaction. Furthermore, businesses seeking a guarantor for their business loans shall possess a sound business plan and effective management policies to minimize loan default risks. If you already have a loan for your business, we at BankKeeping can be your guide to better loan management.