When it comes to running a business, cash flow is king.
With a bank guarantee or indemnity, you’re able to free up this cash flow by providing a cash deposit to your suppliers and a deposit bond to your landlord if you’re leasing commercial premises.
Not only do you not have to pay interest on the guarantee but, depending on the security that you use, you can actually earn extra revenue for your business.
How does it work?
Like any other type of business loan facility, the bank guarantee itself is backed by adequate security, whether it’s:
- A residential property
- A commercial property
- Cash security such as savings or a term deposit
With a residential property, you can get a guarantee up to 80% of the property value and with commercial property, this drops down to anywhere between 50-70% of the property value, depending on whether the property is considered standard or specialised.
For example, if you have $250,000 owing on a $650,000 residential property, you can actually get a guarantee up to $400,000.
When applying for a bank guarantee facility, you don’t have to apply with the same lender that holds the loan on your residential or commercial property.
However, when it comes to using cash as security, the cash must be deposited with the same lender providing the guarantee.
Is there a limit on what bank guarantee I can get?
As long as you have sufficient security, there is no limit on the guarantee you can qualify for.
Many commercial property developers, for instance, arrange for multi-million dollar bank guarantees to pay their suppliers.
Bear in mind that in most cases the bank won’t do a guarantee for less than $1,000.
If you need a bank guarantee, call us on 1300 889 743 or complete our free assessment form and one of our mortgage brokers can help you.
Who uses a bank guarantee?
A bank guarantee is popular with start-up businesses that either want to keep their cash flow working in the business or simply don’t have the money to pay large cost upfront, particularly in the first 3-6 months of operations.
If you use the bank guarantee effectively and you don’t default on your rent or your suppliers, it can also help to create stronger relationships and a level of trust, meaning that they work with you more readily if things go pear-shaped in the future.
Renting commercial space
Depending on the lease agreement, the commercial landlord may ask for anywhere up to 6 months rent as a deposit bond to lease the property.
If the rent is $10,000 a month, that’s $60,000 that you’ll need to pay upfront to the landlord, an amount that most new businesses simply don’t have on stand by.
Although you don’t lose that money since it’s a bond, it’s still an essential cash flow that you’ll have tied up, sitting and doing nothing on your state’s bond board.
With a bank guarantee, you can avoid this upfront commercial cost.
Depending on the industry you operate in, you may be dealing with suppliers or distributors on a regular basis.
Some suppliers only do “cash on order”, however, depending on the volume of goods that you’re purchasing, others may offer you a credit limit backed by your bank guarantee.
A credit limit is an agreed term up to a certain limit for you to settle your debts.
For example, if you run a cabinet making business, you would be purchasing timber in bulk and tools in bulk.
Because of this, your supplier may offer you a credit term of 90 days up to $200,000, confident that they can call on the bank guarantee should you be unable to pay your bill in that time.
Again, the indemnity guarantee is really for business owners that want get over that big hump when they first start their venture.
Some even negotiate with their supplier for 180-day credit limits so they can avoid rushing and stressing to making payment while still getting the goods upfront.
How do I qualify?
Applying for deposit bond
The bank will generally go through all the same checks and balances as if they were approving a loan including your capacity to cover the guarantee as well as any remaining debt on your property security.
For example, if you have a house worth $1 million with a $250,000 home loan and you need a $250,000 guarantee, the bank wants to make sure that you can service $500,000.
The reason is that if you default with your suppliers or on your rent, your bank is required to pay out your suppliers or landlord. It’s at this point that the $250,000 bank guarantee turns into a loan and you have to pay it back.
Applying for a credit limit
When it comes to negotiating a credit limit with a supplier, they essentially go through a similar process as a bank would and questioning your ability to make payment when the credit term rolls around.
They’ll want to know things like:
- How long you have been in business
- What your turnover over was in the past financial year based on your most recent business financials
- What terms and credit limit you’re looking for and whether it’s a risk they’re willing to take
Do I pay interest?
Although the guarantee is secured in very much the same way as a typical mortgage, you’re not actually borrowing any money from the bank so interest doesn’t apply.
However, you will need to pay a yearly fee for the facility, which can be anywhere between $1,000-$1,500 although your mortgage broker can help you negotiate this with the lender.
What are the benefits of a term deposit?
There is a particular benefit of using a term deposit as a bank guarantee that many people overlook.
Instead of giving your landlord a deposit bond where it sits doing nothing on a bond board, you can invest it in a term deposit with the bank earning interest of 2.5% per annum, for example.
You’re actually earning interest and not using any of your own money in upfront costs!
Even with the yearly fee that applies to using a bank guarantee, it often makes financial sense to pay your suppliers and landlord in this way, at least early on in your business.
Bear in mind that you won’t be able to touch the funds until the guarantee is removed.
What are the downsides of a bank guarantee?
Although you’re only paying a nominal yearly fee to use a bank guarantee, it’s important to keep in mind that if you’re using your property as security, specifically, your available equity is tied up in the guarantee.
This prevents you from using that equity for investment purposes, whether it’s for personal or business reasons.
The other thing to remember is that there are solicitor’s fees involved in “upstamping” the mortgage, which is another way of saying that the purpose of the loan needs to be changed.
A higher rate of mortgage duty will apply to the new, up-stamped portion of the mortgage.
Do you need a bank guarantee?
Call us on 1300 889 743 or complete our free assessment form today.
We can let you know how to qualify for a bank guarantee!