Letters of Credit: Plain and simple, a letter of credit is a bank’s promise to pay a certain amount that’s owed by a tenant or a borrower. Banks issue letters of credit as a way to ensure sellers that they will get paid, as long as they do what they’ve agreed to do. This is usually a more common route for small business owners or startups with not a lot of business history or revenue. This also appeases a landlord who is considering a startup business with limited revenues or credit for an office lease.

When a tenant gets a letter of credit from the bank, it basically performs the same thing a personal guarantee. If the tenant defaults on its rental payment, the bank takes over and begins to paying rent to the landlord. It is basically the same thing a personal guarantor would do, with the exception that it is a bank.

Increased Security Deposits: Landlords will forego the personal guaranty if they feel comfortable with the tenant’s business plan, plus an increased security deposit usually makes them feel comfortable that if the tenant goes out of business, they have this additional money to count on while they get the space vacated and re-leased to someone else. Another good thing about increased security deposits is that you can negotiate with the landlord certain things like having a portion of the deposit burn-off as prepaid future rent, provided you don’t miss a payment the first or second year, etc.

Things to keep in mind: Letters of credit diminish an existing line of credit, and are reflected on the contractor’s financial statement as a contingent liability. Having assets tied up are counter-productive to both the owner and contractor. The business owner’s cash flow in funding initial stages of construction and retention amounts throughout a contract term can be adversely affected when liquid assets are pledged to a bank or the bank reduces its borrowing capacity as a result of the issuance of a letter of credit. Also, increased security deposits may tie-up your starting capital and put strain on your cash-flow.