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It is critical to understand the difference between a personal guarantee and a validity guarantee. The difference between the two is key to understanding your invoice factoring paperwork.

Difference Between a Personal Guarantee and Validity Guarantee

Difference Between a Personal Guarantee and Validity Guarantee

By law, a guarantee is an undertaking to answer for the payment or performance of another person’s debt or responsibility in the event of a default by the person primarily accountable for it. Therefore, a guarantee is a promise from your business to your factoring company. This ensures that it will be able to recover the upfront payment they have provided you in case your customer defaults to cover the invoice.

You can identify two types of guarantee, personal and validity.

What is a Personal Guarantee?

A personal guarantee is an individual’s legal promise to repay charges to business. Meaning, the individual provides a personal guarantee that in case the debt is left unpaid, the individual guarantor takes the responsibility personally. The personal guarantee often provides an extra level of protection to lenders who want to ensure the recovery of their money. Therefore, a personal guarantee induces that as a business, you are personally liable. Personal guarantees usually occur when there is a shortfall on the facility, which is generally limited to an agreed amount. However, you will still be responsible for any shortfall, no matter what the reason.

The use of the personal guarantee is not only by traditional lenders. Factoring companies who wish to claim personal assets not related to the business itself use this. The reason for this is to send payment back in the case of a defaulted debt. This guarantee puts your assets as the first source to recover the deficit before taking any action against your customers.

Many believe this type of guarantee to be extreme since you have to be willing to assume the risk personally. Therefore, it is crucial to reflect if you can tighten your assets to your business, especially when considering signing a personal guarantee. Discussing this matter with your factoring company is then vital as only your factor can release you from this guarantee. Additionally, they can provide you a different alternative option.

What is a Validity Guarantee?

On the contrary, a validity guarantee is not a promise to repay the loan. It is, instead of a pledge of financing the assets. Generally, receivables are valid. A validity guarantee is a special kind of guarantee used in Invoice Factoring & PO Funding when many individuals or a corporation own small businesses. It is a guarantee that states the information submitted on a borrowing base certificate or factored invoices are correct. It holds the signer liable in the case of fraud or misrepresentation. However, it doesn’t contain the signer responsible for credit loss if a non-recourse facility. Therefore, most invoice factoring companies prefer to use this less extreme kind of guarantee, which ensures the state of your accounts receivable, their validity, exclusivity, and collection.

In a commercial transaction, a validity guarantee may be preferable to a personal guarantee. This is because it allows you, as an owner, to personally avoid the credit risk.

Under a validity guarantee, specific requirements need to respect:

  • You must forward any misdirected payments to the factoring company. For instance, if your customer pays you instead of your factor, then you need to notify your factor. After such notification, you then need to send him the owed money.
  • A provision granting the factor the priority and the rights allowed money in the unfortunate case that your business files for bankruptcy.

In exchange, your factoring company will then agree to provide all needed invoice documentation to your customers. It will simplify their payment process and also fulfill any other essential requirements necessary to continue to do so. This way, your factoring company assumes the risk regarding a potential non-payment of the purchased invoices. Both you and your company have protection in case your customers default on their accounts.

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