If you’ve tried to wrap your head around debentures and ended up more confused, you’re not alone. Debentures can be difficult to understand.
Straight away, let’s clear one thing up - a debenture is not a financial product; it’s a document used between the borrower and lender that ultimately acts as protection for the lender.
We’re sure you’ve got many more questions, so hopefully, this piece will give you some answers.
What is a debenture?
In simple terms, a debenture is an agreement between the lender and borrower on behalf of their business. A debenture stipulates which assets are being secured against the loan, the loan term, and the loan rates and charges. It protects the lender’s money by giving them security over the borrower’s assets.
Once signed, the lender has 21 days to file it with Companies House. If they fail to do this, they won’t be at the front of the line of creditors if your business goes bankrupt. This means they’ll be as equal as every other creditor awaiting their money.
Read on to learn more about how they work and whether you need one.
How do debentures work and do you need one?
Debentures aren’t always needed for every loan application, so if you’re just looking for a small business loan, you probably won’t need to sign one.
However, if you’re looking for a larger loan, lenders may want you to sign one. A debenture serves to protect the lender’s investment - it gives them security over the borrower’s assets. So if your company goes bankrupt, they’re first out of all your creditors to get their money back.
If you fail to repay the loan as agreed, the lender can claim against your business assets.
It’s important to note that a debenture can only be taken out against a limited company or limited liability partnership. Lenders cannot take out a debenture on a sole trader or partnership.
What is a floating charge versus a fixed charge debenture?
In your research, you might have come across both terms, but what do they mean? Both determine how your company assets will be secured for the loan, but they mean very different things.
A fixed charge debenture
A fixed charge is when the lender agrees to take something ‘fixed’ like your premises or your car, something that isn’t usually gotten rid of, as security for the loan. If you default on repayments, the lender can seize your asset as payment for the loan. This option might limit the fluidity of your business, i.e. you can’t buy or sell assets whenever you want.
A floating charge debenture
A floating charge means the assets your loan is secured on isn’t fixed. So your lender could take your inventory or trade receivables as security for the loan. Which means you have more freedom to buy and sell assets as you wish. If you don’t repay the loan as agreed, the lender will seize all of your assets within that class and sell them quickly to take payment for the loan.
An example of a debenture
Let’s say you already have a restaurant, but you’re looking to expand your business and open new premises, you might apply for a loan to access the cash you need to make that happen.
And because this loan might be hefty, the lender may require you to sign a debenture for added security. This debenture might have a fixed charge as you’ve offered up your current restaurant as security.
Signing a debenture means should your business become insolvent, the lender will get paid first in the line of creditors. Then, if you repay the loan as outlined in the debenture, you’ve fulfilled your agreement, and that’s the end of it.
Can I get a secured and unsecured debenture?
In the UK, most lenders offer secured debentures; finding an unsecured one is pretty unusual.
A secured debenture means the lender’s investment is protected - there’s less risk for them in these instances. If you fail to repay, they can just claim against your assets, and if you’ve got a fixed charge secured debenture, and you need to sell assets to pay debts, you’ll first need to pay the lender or receive permission from the lender to sell.
With an unsecured debenture, a lender would simply wait their turn amongst other creditors to be paid - they don’t jump the queue.
The Pros and cons of debentures
When it comes to any financial transaction, you need to know your stuff before you sign on the dotted line. Debentures have pros and cons; weigh them up below.
The Pros of debentures
- You can access large sums of money to invest into your business, growing it quickly
- With a debenture in place, this usually means fixed interest rate payments
- A debenture can mean access to a cost-effective long-term lending solution
The Cons of debentures
- If you default on loan repayments, the lender can claim on your assets
- You may have to provide a personal guarantee therefore you pay if the company cannot
- If you have a fixed charge debenture, you lose freedom over how you buy and sell your assets
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