Debentures are commonly used by traditional lenders when providing high-value funding to large companies. If your business has scaled quickly and is moving from the SME category and becoming a large organisation, it's an important concept to get your head around. Here’s what you need to know.
In the UK, the term 'debenture' refers to a secured loan agreement between a lender and a borrowing business. More specifically, it’s a tool used by lenders to define conditions such as how a business’ assets will be used to secure a loan, along with other details. Debentures usually enable large companies to borrow money at a fixed rate of interest, in the medium to long-term.
If that's still unclear, don't worry. Debentures are often misunderstood. We'll unpack how they work later. But for now, it's important to remember that a debenture is a tool used to define the specifics of a loan, rather than being an actual financial product itself.
Another thing that can confuse people is that the term means slightly different things in different markets and regions. Because of this, it's easy to find conflicting information when researching debentures. In this article we'll discuss the most common versions that you're likely to come across in UK business.
When a large secured loan is put in place in the UK, both parties agree to the loan amount and the interest rate, which is usually fixed at a certain percentage. To insure against the risk of the loan, the borrowing business’ assets are used as security – in case they're unable to repay what's owed.
As a legal record of the secured loan, a debenture agreement is put in place and registered at Companies House as a charge against the business – within 21 days of the agreement being made. If the debenture isn't filed at Companies House and the borrower subsequently becomes insolvent, then the lender would only have as much claim to what's owed as any other unpaid unsecured creditor.
So, large secured loans require the use of a debenture. Smaller unsecured loans are instead backed up by a personal guarantee.
A retail store wants to borrow a large sum of money from their bank to open a new shop, using its current premises as security against the loan.
An agreement is put in place using a fixed charge debenture. Registered at Companies House, the debenture details the loan specifics, including the amount, interest rate and term length, as well as the fact that the loan is secured against the business’ original premises.
If the retailer pays back the loan according to the debenture terms, then no further action is taken. However, if the company goes into liquidation because it's unable to pay its debts, the debenture would ensure that the lender is repaid before any other creditors.
A debenture charge is the part of the agreement that documents what the loan is secured against. There are two types of charge that can be granted by a debenture. There are fixed charges, which grant the lender possession and ownership of ‘fixed’ assets in the event of non-payment. These assets might be property (as in the above example), vehicles or machinery.
Then there’s a floating charge, where it’s acknowledged that the assets the debenture is secured against might change over time – such as stock. This means a borrower can continue to move and sell them freely until one of the events specified in the agreement occurs, such as the company defaults on its loan. In this case the charge will become fixed and they will no longer be able to move or sell the assets without the permission of the lender.
There are lots of different types of debentures that can be used in relation to business. Here are the most common:
Almost all UK debentures are secured. As above, this means the lender leverages a borrower's assets to provide security against the loan. If there is a default in repayment then the asset will be sold to pay off the debt.
Unsecured debentures, also known as ‘naked’ debentures, are not secured by any charge against the borrower's assets. It’s rare to come across unsecured debentures in the UK business environment.
Some debentures are redeemable, others are irredeemable. The former means that on a specific and agreed date, the borrower is legally bound to repay the debenture holder, or lender. This can be done in one lump sum or in installments over an agreed period of time. An example of a redeemable debenture is a fixed term loan.
On the other hand there are irredeemable debentures, which are also known as perpetual debentures. Under this kind of agreement there is no specific time of redemption, which means they continue until a company goes into the liquidation process. An example of this could be a business bank overdraft.
If you're looking to borrow a relatively small sum with a business loan, you may not need to worry about debentures. Check out our summary of the top 10 small business loans to see what's on offer.
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