What on earth is a debenture?
Debentures are an instrument available to business lenders in the UK, allowing them to secure loans against borrowers’ assets. Put simply, a debenture is the document that grants lenders a charge over a borrower’s assets, giving them a means of collecting debt if the borrower defaults.
Debentures are commonly used by traditional lenders, such as banks, when providing high-value funding to larger companies. To register a debenture, a lender simply has to file it with Companies House. This can usually be done in a matter of days.
The different types of debenture charge
There are two types of charge that can be granted by a debenture, with lenders tending to seek one or both of the following.
With this type of charge, a lender can ensure it is the first creditor to recoup any outstanding debt if a borrower defaults on a loan. In essence, it grants the lender possession and ownership of a borrower’s asset in the event of non-payment, with any subsequent sale being used to pay off the remaining debt. The most common form of fixed charge is against property.
As well as covering the freehold or leasehold of a property, a fixed charge can cover building fixtures, trade fixtures, fixed plant and machinery, and motor vehicles. With a fixed charge, the borrower would not be able to sell the asset without the lender’s permission, and the proceeds would usually go to the lender or towards a new asset, which the lender then places a fixed charge over.
A floating charge can be attached to all of a company’s assets, or specific classes of asset, including stock, raw materials, debtors, vehicles, fixtures and fittings, cash, and even intellectual property. The ‘floating’ nature of the charge means these assets might change over time, with the borrower able to move or sell any assets during the normal course of business.
It’s only when the lender looks to enforce the debenture in a default situation that the floating charge ‘crystallises’ and effectively becomes a fixed charge. From that point, the borrower will no longer be able to deal with the assets in question, unless they have permission from the lender. In an insolvency or liquidation, a floating charge will give a lender priority over unsecured creditors when it comes to the allocation of repayments.
It is possible for a lender – or lenders – to have multiple debentures on the same borrower. These can either be multiple fixed debentures against different specific assets, multiple floating debentures, or a mixture of both. When the first lender places a debenture on the company, they often prevent a second lender adding another without their consent.
Where there are multiple lenders with debentures that have recourse against the same borrower’s assets, the lenders will agree priority of payments between themselves. This is usually documented between the lenders and borrower by way of a Deed of Priority.
Debentures - good or bad?
In essence, debentures are a necessary evil of raising money for a business. Some lenders won't lend above a certain amount without a debenture, so regardless of how much you’re looking to borrow, you should be prepared to offer up your assets as security.
If you're uncomfortable putting your company's assets on the line, an unsecured loan might be a better option for your business, although it could mean borrowing less and paying a higher rate of interest.
Steady on, Donald!
If you’re reading this article in the USA, you can ignore the above, unless you found this page as part of your research into the UK finance industry.
Believe it or not, ‘debenture’ means something completely different in the United States. Rather than an instrument that’s used to secure a loan against company assets, a debenture in the USA is an unsecured corporate bond that companies can issue as a means of raising capital.
With no collateral involved, this type of debenture is backed only by the reputation and creditworthiness of the business that’s issued it. As such, anyone investing in a debenture in the USA does so on the belief that a company will have no trouble making repayments.
There are two types of debenture in the United States: convertible and non-convertible.
A convertible debenture can convert into equity shares of the issuing company after a certain amount of time. It's an attractive proposition for investors, and offers low interest rates for businesses looking to raise capital.
A non-convertible debenture doesn't convert into equity in the issuing company. However, it usually offers a higher interest rate than a convertible debenture, making it a more expensive form of capital for businesses.