Company Debentures: The Pros and Cons | The Insolvency Experts

What is a debenture?

In the UK, a debenture refers to a secured loan agreement between a lender and you, the borrowing business. A debenture is a tool used to define the conditions of the loan, such as how much you’re borrowing, the interest rate and how business assets will be used as security.

Debentures are often misunderstood, so it is key to remember that it is a tool used to define the specifics of a loan, rather than the actual financial product itself.

What is the purpose of a debenture?

A debenture gives the lender security over the borrower’s assets. Most often, a debenture is used by a bank to take security of their loans.

A debenture loan can only be taken on by a limited company or limited liability partnership, it cannot be taken over by a sole trader or standard partnership.

Example of a debenture

You run a bakery store and want to borrow a large sum of money for your bank to open a new shop. You intend on using your current premises as security against the loan.

You and the lender sign a debenture. This will detail the specifics of the loan, such as:

The amount
The term length
The interest amount
The fact that the loan is secured against your business’ original premises.

If you pay back the loan fully according to the debenture terms, no further action will be taken. However, if your company goes into liquidation because you’re unable to pay your debts, the debenture will ensure that the lender is repaid before any other creditors.

How do I know if I have a debenture registered against my company?

If you have had a debenture against you, you will have had to sign the debenture as company director. Once the debenture is signed, it will be filed at Companies House.

Use the free Companies House website to find your company and look under charges. This will list any debentures charged against your company in order of date.

If the debenture has been issued by a high street bank or other business lender, you will have to sign a personal guarantee. The lender will advise you to seek independent legal advice when you’re signing the guarantee.

Can I have more than one debenture registered against my company?

Yes, you can have more than one debenture registered against your company. Debentures will rank in order of the date created, unless one lender has given another a deed of priority.

If you find a previous lender who has been repaid but has not removed their debenture, you should ask them to remove it.

Sometimes lenders may sign a negative pledge, which is an agreement not to give a debenture to someone else.

Types of debenture charge

There are a few types of debentures and subsequent secured creditors – it’s important that company directors are aware of the differences between them.

Fixed charge

A fixed charge debenture means that the loan is secured against a specific asset such as your car, property or piece of equipment. If you fail to pay back your loan, the lender has the right to take ownership of that asset in order to settle the outstanding loan balance.

The lender may not allow you to sell whatever your loan is secured against, which could limit the way you operate your business until you’ve paid it off.

Floating charge

Floating charge debentures are not secured against a particular fixed asset. They are secured against an asset with a variable value, such as your inventory. The value of your inventory may change over the duration of the loan, but the lender will have agreed that its value is high enough to act as security for the amount you have borrowed.

This kind of debenture leaves you free to trade, buy and sell stock as normal even though a lender has your inventory as security. Once you pay off your loan, you’ll regain full control.

Multiple debentures

It is possible for a lender, or lenders, to have multiple debentures on the same borrower. These can be fixed debentures, multiple floating debentures or even a mixture of both.

When the lender places a debenture on the company, they often prevent a second lender adding another without their consent. However, where there are multiple lenders who have debentures against the same borrower’s assets, the lenders will agree priority of payments between themselves.

This is typically documented between lenders and borrower by way of a Deed of Priority.

To find out more about how lenders are ranked, view our extensive guide outlining the difference between secured and unsecured creditors.

Convertible debentures

A convertible debenture can convert into equity shares of the issuing company after a certain amount of time. It’s a compelling proposition for investors, and it also offers low interest rates for businesses looking to increase capital.

Non-convertible debentures

Non-convertible debentures don’t convert into equity in the issuing company. However, it usually offers a higher interest rate than a convertible debenture. This makes it a more expensive form of capital for businesses.

What’s the difference between fixed debentures and floating debentures?

A fixed debenture means that the loan is secured against assets and, if you fail to repay the creditor, they have the right to take ownership of that asset in order to settle the outstanding loan.

However, a floating debenture means that the loan is not secured against any fixed assets. It is secured against assets with variable but sufficient value, such as inventory. Once your loan has been repaid in full, you will regain complete control.

Read our handy guide to learn more about fixed vs floating charges.

How do debentures work?

In simple terms, a debenture is the document that grants lenders a charge over a borrower’s assets. This gives lenders a means of collecting debt if the borrower defaults.

If the borrower defaults, the lender has the right to appoint an administrator to take control of the company. The threat of an administrator being appointed can be enough to make a company repay the debt, or agree to the terms to repay it.

What are the risks of debentures?

The majority of debentures have fixed interest rates and a fixed repayment of capital. Where assets are held to maturity, lenders will receive the expected amount regardless of interest rate movements.

This risk here is that fixed-rate debentures are exposed to the opportunity of a better rate of return elsewhere if the interest rates were to increase.

Most debentures do not offer a readily available exit mechanism, which holds a company liquidation risk. In times of financial difficulty, this can compromise growth and may pressure some companies towards insolvency.

Pros and Cons of Debentures

Pros:

Control of the company by existing shareholders is not reduced, so profit sharing remains in the same proportion;
Debentures can encourage long term funding to grow a business;
Financial protection and reassurance is provided for directors regarding their personal funds;
Debentures ensure a higher position in the list of creditors who need repaid.

Cons:

There is no flexibility for the borrower and their company in their obligation to make interest payments on the debenture;
Holding a debenture means the lender loses their right to take a share of the company profits;
Restrictions imposed by securing the debenture with an asset/s takes away the management’s freedom to control or use the assets at will.

FAQs about Debentures

How do I know if a debenture is valid?

Normally, you would ask your solicitor to check the validity of a debenture. Any funds must be advanced at the same time as the debenture is created, as well as being registered within 14 days to be valid.

How does a debenture holder enforce security?

The lender, holder of the debenture, has the right to appoint an administrator to take control of the company if the borrower defaults on the loan.

Lenders can threaten to appoint administrators, which is often enough to push the borrower to repay the debts, or agree to the terms of repayment.

If a company becomes insolvent, does a debenture holder get their money back?

Yes, a debenture holder will get their money back through the sale of assets. The administrator, or liquidator, must hand over the assets listed in the debenture to the lender. The lender usually then agrees for the administrator to sell the assets for a fee.

Any assets can fall into a fixed or floating charge category by the debenture. Fixed assets include items such as property, vehicles fixed to the floor and debt books. Floating assets include moveable assets such as trading stock, equipment and furniture.

Do I need the consent of the debenture holder to sell company assets?

Consent is most likely needed to sell assets subject to a fixed charge. If the sale of floating charge assets is out of the normal course of trade, it would typically need the lender’s consent; for example, selling the stock to a new business owner.

It’s best to check the terms of a debenture before trying to sell anything as some sales may be invalid.

We hope that this guide has helped you to understand debentures and how they could affect your business.

At the Insolvency Experts, we provide friendly and expert business debt advice tailored to your specific needs. Feel free to contact us today if you are worried about a debenture or your business finances.

The Pros and Cons of Company Debentures