A debenture is a common instrument used by lenders to secure a loan against assets. In the case of a business loan, the assets can be business-owned or they can be owned by the person who signs for the loan – typically the company director.
From the lender’s perspective, a debenture offers a means of collecting debt in the event the borrower becomes unable to repay it. This is achieved through a legal mechanism whereby a charge over the borrower’s assets is placed.
Typically, that charge is placed over business property or personal residential property. The charge is removed only after the debt has been repaid.
From the borrower’s perspective, a debenture is a means of securing a business loan. It’s normal practice for a debenture to be demanded on high-value funding. All lenders from high-street banks to independent institutions use debentures. There are two types you need to be aware of, which we’ll delve into below.
A fixed charge or fixed debenture grants the lender possession of the asset or assets in the event of non-repayment. This type of charge also grants the lender ‘first dibs’ on the assets, so they can recoup any outstanding debt first.
A fixed charge can cover the freehold or leasehold of property, or any valuable assets the lender takes control over. The borrower isn’t able to sell the assets without the permission of the lender at any time during the agreement due to the charge. The assets must remain the same, so they can’t be changed. Hence the phrase ‘fixed’.
In the event of non-repayment, the lender will seize control of the goods and sell them, with the proceeds generated going towards clearing the debt.
The characteristics of a fixed charge apply to a floating charge except for one major difference – the ‘floating’ nature of this charge means the assets can change.
This gives the borrower (debtor) a greater level of flexibility, allowing them to move and sell assets during the normal course of business. As you’d expect, this is the preferred option for the borrower but the results of non-repayment remain the same.
In other words, in the event of non-repayment the floating charge is triggered and becomes a fixed charge. As we’ve already discussed, this means the borrower can’t sell the assets without the permission of the lender. And in the event of liquidation or insolvency, it gives the lender the legal right to take control of goods and sell them.
Debentures – the bottom line
Debentures are necessary to secure business funding. It is normal practice for lenders, no matter their size, to request a debenture when lending to business.
The only way around a debenture is to take out an unsecured business loan. This means you borrow without a debenture. The catch is you have a lower borrowing limit and the interest rates are usually higher to reflect the increased risk the lender’s taking.