Nobody goes into business thinking they will fail, but unfortunately, it’s a possibility that lenders have to consider when handing out loans, which is where debentures come in. Learn everything you need to know about debentures, starting with our debenture definition.
Simply put, a debenture is an agreement made between a borrowing company and a lender. It confirms that the loan is secured against the company’s assets. Then, the debenture is registered at Companies House, so it’s an official record. This means that if it fails, the lender will get their money back. The debenture is intended to protect the lender if the business goes under. However, should they fail to register the debenture at Companies House within 21 days, it can be more difficult to recover the debt. Debentures also stipulate that the lender claims its costs from the business, not from personal assets.
What should a debenture document include?
The following should be included in a debenture document:
The total borrowed
The interest rate
Whether that interest rate is fixed or variable
Total to be repaid
Timeframe for repayments
Any other charges
‘Fixed’ and ‘floating’ debentures meaning
There are two different types of debentures, and you should always confirm which type you are signing up to:
Fixed debentures – This type of debenture is secured against a fixed asset like real estate, automobiles, or machinery. With this debenture, you may not be allowed to sell the asset, which means you wouldn’t be able to expand or move, upgrade equipment, or even get a new car until the loan is paid off.
Floating debentures – Floating debentures are secured against assets that don’t have a set value, for example, inventory. Unlike a fixed debenture, you can continue to sell and buy freely. If the business does fail, the floating debenture “crystalizes,” i.e., the value of the asset, which was previously unclear, is finalised.
It is possible for floating debentures to be placed on all of a company’s assets and a fixed debenture to be placed on one particular asset. In this case, the fixed debenture takes priority when it comes to a lender claiming back payment.
While fixed and floating debentures are the most prominent, there are several other types of debentures, including:
Secured: These debentures are secured against an asset (which will be sold to pay any debt).
Unsecured (also known as ‘naked’): These debentures are not secured against any assets, so the lender will not have any specific claim to any given asset should the company fail. Due to this, the interest rates for unsecured debentures are often higher.
Redeemable debentures: These require the borrower to repay their loan, either in whole or in instalments, by a fixed date.
Irredeemable debentures: These don’t have a due date, with repayment being set for when the company goes into liquidation or is dissolved.
Debenture advantages and disadvantages
As with any loan, there are pros and cons to consider. Here’s a little more information about the advantages and disadvantages of debentures:
Long-term funds that can be more cost-effective than other loaning options
A debenture loan gives no control (like voting rights) to the lender, unlike taking on investors
In the case of a ‘naked’ debenture, there is no pressure to repay within a strict time frame
Profits are not involved in the agreement
Can limit changes and expansion
For redeemable debentures, the amount must be paid on the given date, regardless of this places a financial strain on the business or not
What is the difference between loan and debenture?
All debentures are loans, but not all loans are debentures. A loan must be paid back by a set date and must be secured against something of equal value. A debenture doesn’t need to be taken out against something of equal value, simply something deemed sufficiently valuable, which is why they can be secured against something variable like inventory.
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