What is a Debenture?

In last week’s blog, I looked at personal guarantees. This week I’m examining debentures. What are they? And what role do they play?

Debentures are essentially all about insolvency. In other words, if the business has taken a business loan and then the worst happens and the business becomes insolvent, what happens next? Let’s find out.

What is a debenture?
A debenture is designed to give protection to a lender or finance company who has lent funds to a business. What a debenture does is give the lender a priority position in the event that the business to whom the loan has been made becomes insolvent. Another way of putting it is that in the worst-case scenario, and the business becomes insolvent, it gives the lender ‘a seat at the creditors table’.

It’s important that a debenture is filed with the Registrar of Companies at Companies House, because if it’s not filed, in the event of the business becoming insolvent, the lender would simply join the list of unsecured creditors.

What is a fixed charge?
You may have heard lenders talk about a fixed charge. This offers lenders extra protection. The extra protection comes from material assets like machinery, property and land, and these assets cannot be sold or disposed of without the business either repaying the loan or getting consent from the lender.

What is a floating charge?
A floating charge is similar to a fixed charge, except that instead of using specific fixed assets, a floating charge uses a group of assets within the business. With a floating charge, the business can buy and sell assets as a normal part of their business.

So, whilst a fixed charge stops the borrower from selling specific assets without first repaying the lender or getting their agreement, a floating charge on the other hand, isn’t held against specific assets, but rather over groups of assets or even a business’s total assets.

Floating charges are usually applied to assets which are more naturally bought and sold through the day-to-day activities of the business, and these can include:

• Stock
• Cash
• Materials

It’s important to be aware that if a fixed charge and a floating charge are applied to the same asset, the fixed charge takes priority in the event of insolvency.

Debentures vs personal guarantees
For unsecured business loans, lenders will often use personal guarantees as a way of covering their risk. They would do this instead of registering a debenture. As I explained in last week’s blog, personal guarantees (PG’s) mean that the business owner is personally responsible for paying back the loan if the business becomes unable to do so. This means that the personal assets of the business owner are at risk.

Debentures on the other hand are either fixed charges, floating charges or both over the assets of the company and protect the lenders position should the worst happen, and the business becomes insolvent.

Whether the business loan you take out is secured or unsecured, whether the lender requires a debenture or a personal guarantee, at the end of the day it is all about the lender having a way of getting their money back should things go wrong.

Of course, no business owner wants to think in terms of things going wrong, but nevertheless it is only common sense to understand the different ways a lender can secure their position, and what the implications are for your business should the worst happen.