What is a Guarantor?
In general, ais a promise to take responsibility for another company's financial if that company cannot meet its . The entity assuming this responsibility is the guarantor.
How Does a Guarantor Work?
Let's assume XYZ Company has a subsidiary named ABC Company. ABC Company would like to build a new plant and thus would like to borrow $10 million from a bank. The bank loan. By doing so, XYZ Company becomes a guarantor -- it agrees to repay the loan using flows from other parts of its business if ABC Company is unable to generate enough cash on its own to repay the debt.
Often a parent company a financial guarantee of issued by one of the parent's subsidiaries, but there are plenty of other situations that might involve guarantees. For example, vendors sometimes require customers to become guarantors if the vendor is uncertain about the customer's (this most often happens in transactions involving expensive equipment or other physical property). In these situations, a customer's bank might be a guarantor of the customer's payment, meaning that the bank pay the vendor if the customer does not.
Financial guarantors don't always the entire amount of a . In , for example, the financial guarantor might only guarantee the of interest or , but not both. Sometimes more than one company can be the guarantor on a security; in these cases, each guarantor is usually only responsible for a pro rata portion of the , but in other cases, each guarantor may be responsible for the other guarantors' portions if they also default on their responsibilities.
Railroad companies are well-known for their guaranteed bonds because in order for a railroad company to lease another company's railroad, the lessee must often guarantee the debt of the lessor.
Why Does a Guarantor Matter?
default on the if the is too large or if the guarantor is already struggling for other reasons. Regardless, guarantees provide an extra layer of security, which is why guaranteed securities often get higher ratings.
Historically, financial guarantors disclosed the nature and size of their guarantees in the to their . It is important to that guarantees issued between parents and their subsidiaries do not have to be booked as liabilities. Examples of this include a parent's of a subsidiary's debt to a third party or a subsidiary's of the parent's debt to a third party or another subsidiary.
All must, however, be disclosed. The guarantor must disclose the nature of the (terms, history, and events that would the guarantor on the hook), the maximum potential liability under the , and any provisions that might enable the guarantor to recover any paid out under the .