In the world of business finance, debentures play a crucial role in helping companies raise capital. But what exactly are they, and how do they function? Let’s delve into the details to understand their significance and usage.
What is a Debenture?
A debenture is a type of security that a company provides to a lender in return for funding. This funding can come in various forms, typically as a long-term loan. In exchange, the debenture gives the lender security over the company’s assets. This security can be a fixed charge on specific assets like property or a floating charge on assets that change frequently, such as cash or stock.
Typically banks, factoring companies, or invoice discounters use debentures to secure their loans. They can only be issued to a limited company or a limited liability partnership; it cannot be issued to a sole trader or a standard partnership.
How Debentures Work
Most commonly they include both fixed and floating charges:
- Fixed Charge Assets: These typically include book debts under a factoring agreement, freehold or leasehold property, and plant and machinery that is fixed to the floor.
- Floating Charge Assets: These are generally movable assets not covered by the fixed charge, such as trading stock, equipment, furniture, and computers.
Similar to mortgages, debentures are ranked based on when they were issued, although lenders can agree on a different order of priority through a formal agreement.
Holding a debenture gives the lender certain rights over the company’s assets, often requiring the company’s consent to sell or dispose of fixed charge assets.
For example, if a company wants to buy a trading premises but lacks the funds, it can take a loan from a bank. The bank would then take security, possibly in the form of a debenture, which might include a fixed charge on the property, similar to a mortgage.
How do I apply for finance secured by a debenture?
You can directly approach a bank or lender to discuss the type of financing you need. They will inform you about their available products, which may require the security of a debenture.
Alternatively, you might consider working with a finance broker. These brokers act as intermediaries between you and the banks or finance companies. They will understand your needs, research suitable products, and agree on your preferred facility before handling the application process. Keep in mind that finance brokers have access to different lenders, and not all brokers will have access to every lender. This is an important consideration when seeking finance.
Can I Borrow Without Giving a Debenture?
Yes, there are certainly ways of avoiding the need to give a debenture over your company’s assets.
This typically involves:
- Researching different lenders
- Different lenders will have different views, and some won’t take debentures at all. Using a finance broker is a great way of finding the finance structure that suits you best.
- Different finance products and structures
- Some finance products always involve debentures, invoice finance for example, while other products such as unsecured business loans, are less likely to require them.
- Offering alternative security
- Offering a legal charge over property or a personal guarantee can often be a good way of persuading a lender they don’t need a debenture.
- Reducing the debt amount
- Generally the more you borrow the more likely a lender will want a debenture. Consider borrowing less.
- Negotiating
- Negotiating on all of the points above can often be effective. If other lenders are competing for your business and aren’t requesting a debenture then mention this. Use a finance broker as they negotiate terms with lenders as part of their day job.
Why Are Debentures Important?
Companies use debentures to secure funding for various needs, such as improving cash flow, funding projects, or acquiring equipment. Lenders usually require security for significant loans to protect their interests if the company defaults on repayment. Therefore, companies often have to issue debentures to secure the funding they need.
Debentures place a number of restrictions over the company so it is important that you understand the impact on the management of the business going forward.
How Does a Lender Recover Their Money if the Company Becomes Insolvent?
When a company becomes insolvent, the administrator or liquidator is responsible for handing over the assets covered by the debenture to the lender. Typically, the lender will allow the administrator or liquidator to sell these assets on their behalf, usually for a fee.
How Do I Check if a Bank Has Registered a Charge Against My Company?
As a director, you would have signed the debenture which is then filed at Companies House. You can check this by visiting the Companies House website, where you can search for your company and look under the “charges” section. This will list any debentures registered against your company.
Can My Company Have More Than One Debenture Registered?
Yes, it is possible to have multiple debentures registered against your company. They usually rank in order of their creation date unless a deed of priority has been agreed upon between lenders. If a previous lender has been repaid but has not removed their charge, you should request its removal.
What is a Negative Pledge?
A negative pledge is an agreement that prevents you from giving a debenture to another party. The negative pledge is a key tool for the protection of existing lenders from being subordinated to any subsequent lenders.
Does it Give a Lender Significant Control Over My Company?
Yes, particularly if you default on the loan. The lender can appoint an administrator, block you from appointing your own administrator, or prevent you from going into liquidation. However, the debenture holder typically does not interfere with your day-to-day operations.
If you have provided a personal guarantee to the bank, it might be beneficial to allow them to hold a debenture, as they can use the company’s assets first to recover their loan.
Do I Need the Debenture Holder’s Consent to Sell Assets?
Yes, consent is usually required to sell assets subject to a fixed charge. For floating charge assets, if the sale is outside the normal course of trade (e.g., selling all stock to a new business owner), lender consent is typically needed. It’s important to check the terms of the debenture for specific consent requirements.
Does a Debenture Include a Personal Guarantee?
Often, yes, especially if issued by a high street bank or other business lender. You would have signed a personal guarantee, and if you’re unsure, you should check with the lender. Typically, the lender will require you to seek independent legal advice before signing a guarantee.
Read up on personal guarantees here.
The Bottom Line
Debentures can be a vital tool for a business to secure funding, unlocking a range of finance options from lenders. Understanding the function of a debenture and the potential impacts on the business in the future is highly advisable in order to stay informed as you grow your business.