Collateral and Guarantees in Trade Credit

Security is what a company falls back on when a credit decision goes wrong. It does not reduce the probability that a customer stops paying: it reduces the loss when that happens. Treating the two as the same thing leads to the most expensive mistake in the discipline — approving a weak customer because "there's a guarantee."

When to require security

The requirement belongs in the policy, tied to objective triggers:

• Exposure above a defined amount
• Customer in a higher risk tier
• Company with fewer than 24 months in business
• Terms extended beyond the standard
• An exception approved against policy criteria
• Reinstating credit after a past delinquency

Below those triggers, requiring security usually costs more — in commercial friction and paperwork time — than the risk it covers.

Types of security and what to expect from each

Personal guarantee

The most common in trade credit because it is simple and cheap. The owner is personally liable. In practice, its strength depends on there being locatable, unencumbered personal assets: a guarantee from an owner with no assets is largely symbolic.

UCC-1 filing

A public filing that perfects a security interest in specific collateral — inventory, equipment, receivables. Priority follows filing order, so a first-position filing is worth far more than a later one. Check existing filings before you rely on yours.

Purchase money security interest (PMSI)

A security interest in the goods you sold, which can take priority over an earlier blanket filing when the notice requirements are met and filed on time. It is the strongest practical tool for a supplier shipping inventory, and it is often skipped for lack of process.

Letter of credit

A bank undertakes to pay when documents conform. Strong, predictable and common in international trade. Cost and paperwork keep it out of routine domestic transactions.

Trade credit insurance

An insurer indemnifies part of the loss for a premium. It transfers risk without damaging the customer relationship, and the insurer's own underwriting doubles as a second opinion. Premium, deductible and policy exclusions are the decision points.

Advance rates

Security rarely covers 100% of exposure at face value. Work with a haircut:

• Receivables: 70% to 80%, depending on the account debtor's own risk
• Equipment: 50% to 70% of market value, for depreciation and resale difficulty
• Real property: 60% to 70% of appraisal

The haircut is not pessimism: it is the gap between book value and what a forced sale actually returns, net of enforcement costs.

Documentation essentials

1. A signed credit agreement, not just terms printed on a purchase order
2. Full legal name of the debtor exactly as registered — the top cause of failed filings
3. Timely filing with the right office, in the right state
4. A precise description of the collateral
5. Guarantor details complete, with spousal consent where applicable
6. Expiration dates and continuation filings tracked

Periodic review

Security ages. Equipment depreciates, receivables get collected, filings lapse after five years, and someone else may file ahead of you. Include a security check in the limit review: does it still exist, is it still worth what it was, and is it still perfected?

What to take from this

Security is loss mitigation, not a substitute for underwriting. Tie the requirement to objective triggers, pick the type by how fast it converts to cash, apply a realistic haircut, and treat perfection as part of the credit decision — not as paperwork for later.