What is the point of a bank guarantee?

If you have ever bought or sold a house, you have probably heard of the term "bank guarantee": it is a widely used tool in real estate transactions between individuals. But did you know that the bank guarantee can also be very useful in a business acquisition? In this article, we explain what a bank guarantee is and why it can be wise to use it when taking over a (online) business.

What is a bank guarantee?

A bank guarantee is actually an agreement. In this agreement, a bank (hence the term "bank guarantee") guarantees that it will pay a certain amount unconditionally to the beneficiary of the bank guarantee as soon as the beneficiary requests it.

When do you use a bank guarantee?

Generally speaking, a bank guarantee is used in situations where there is uncertainty. This may be, for example, because the buyer and seller are in different parts of the world. But in the case of a business acquisition, it will often be a different situation with uncertainty: the period between the signing date of an acquisition agreement and the actual transfer of the business. By signing the acquisition agreement, the buyer promises to take over the business for an agreed amount. The seller wants to be sure that the buyer can actually dispose of this amount at the time of transfer. Especially if the period between signing and delivery is longer than usual (in the case of online store takeovers, we label a period longer than 4 weeks as "long"), a bank guarantee should be considered.

This is because anything can happen in the intervening period: for example, the buyer may change his mind, go bankrupt, or spend the money on something else. But things can also happen outside the buyer's control that do have a lot of impact. Think of the Covid pandemic, for example. On the other hand, the seller has already indicated to other buyers that the business has been sold and many expenses have probably already been incurred. In short, the seller is anxious to make sure that the agreed deal is actually carried out as planned. The bank guarantee is a useful tool in this regard.

How does a bank guarantee work?

When the buyer and seller have agreed that a bank guarantee will be provided as security for payment to the seller, the buyer will need to contact its bank. As a beneficiary of the bank guarantee, the buyer will have to remit to the bank a fee for this guarantee.

This guarantee must include the seller as the beneficiary.

Once the bank guarantee is issued, the bank will freeze a balance in the buyer's account in the amount of the issued bank guarantee. If the buyer does not have this amount available, then the bank will also not provide a guarantee.

Once the bank guarantee is issued, the seller can call on it if the buyer (for whatever reason) has not made the agreed payment by the agreed date. The seller then turns to the bank, which will then transfer the agreed amount to the seller. Banks must unconditionally honor any claim by the beneficiary on a bank guarantee. Whether or not the buyer agrees with this no longer matters to the bank: payment is made immediately and the buyer (the guarantor) has no legal options to prevent payment to the seller (the beneficiary).

It is important that the seller actually receives the contract (the document) in which the bank guarantee is worked out, as this can be used to claim the payment.

The expiration date of the bank guarantee

When closing, pay close attention to the expiration of the bank guarantee: without a clear expiration date, the guarantee remains in force and the beneficiary can continue to invoke it. Even if the relevant contract between buyer and seller is no longer even in force.

On the other hand, the end date chosen must be sensible: if the bank guarantee is concluded for a penalty clause, or to cover guarantees and indemnities, then the end date of the bank guarantee must be of a later date than the expiration of the relevant penalty clause/guarantee/indemnity. After all, otherwise the seller will not be able to invoke it in time.

(In the case of a bank guarantee to secure the warranties and indemnities in an acquisition agreement, the roles are of course reversed: then the seller is the guarantor and the buyer is the beneficiary).

What does a bank guarantee cost?

Banks must incur costs to issue a bank guarantee and these costs are, of course, passed on to the guarantor. These are usually handling fees and on top of that a periodic commission that depends on the term of the bank guarantee issued. For the handling fee, one can count on an amount starting from €500. The periodic commissions are a percentage of the guaranteed sum. Think here of +/- 1% of the sum per year. The commission continues as long as the bank guarantee has not been terminated.