What is a debenture?
What is a debenture and how does it work?
A debenture is a form of security that a Company grants to a lender in exchange for funding. The funding can be in any form, and most commonly it relates to a long-term funding facility, such as a loan granted to a company that is repayable over a period of time.
In exchange for access to the funding, the debenture grants the lender security over the company’s assets. This security can be a fixed charge over specific assets such a property or individual chattel assets, or over assets which can be shown to be under the control of the lender, such as debtor receipts which must be paid to a designated client account, or a floating charge over assets which regularly change, such as cash at bank, stock and similar. The most common form of debenture is one which grants both fixed and floating charge security.
Like mortgages, debentures rank in the chronological order in which they were granted, although it is possible for lenders to agree a differing order of priority through a formal document (deed of priority).
Holding a debenture grants the lender powers and rights over the company’s assets, and commonly the company cannot sell or dispose of its fixed charge assets without the consent of the lender.
What is an example of a debenture?
If a company is looking to acquire a trading premises, as opposed to leasing its premises, it may not necessarily have the funds available to buy suitable premises outright. Much like a private individual obtaining a mortgage, the company can approach banks and other appropriate lenders to take a loan to acquire the property.
In consideration for the loan, the bank would take security and a debenture would be one of the types of security the bank may seek, usually incorporating a fixed charge over the property in question, similar to a normal domestic mortgage.
Why do companies use debentures?
Companies require funding facilities for a variety of means. Most commonly, they are to ease cash flow through the business, to fund a specific project or expansion, or to acquire additional equipment required by the company in its trade.
Lenders usually only offer modest loans on an unsecured basis, with significant lending requiring security to protect the lender should the company default on its repayment of the loan.
A debenture is one of the tools available to lenders to secure their interest and as such usually companies have no option but to agree to issue a debenture in order to secure the funding they want.
Can I have a debenture over the assets of my own company?
Yes, you can secure lending you have granted to your own company by way of a debenture. However, it is important to consider that if you hold a debenture you may struggle to obtain lending from banks as they will not wish to rank after you and may only agree to lend if you agree that your security will rank after theirs.
When entering into a debenture it is important to seek proper advice to ensure that the debenture is valid as, if the document and funding is not properly dealt with, your debenture may be ineffective and not grant you the rights you would anticipate.
How do I apply for finance secured by a debenture?
You can directly approach a bank or equivalent lender and advise them as to what sort of facility you require. They will in turn tell you about their product offerings, which may well require the security of a debenture.
Alternatively, you may wish to appropriate an asset finance broker, who will act as an intermediary between you and the banks / finance companies. They will understand your requirements, research the products available to you and agree your preferred facility before handling your application for that facility. It is worth noting that asset finance brokers will have access to varying lenders and not all brokers will have access to all lenders. This should be considered when seeking finance.
If you are not looking for lending, but wish to introduce funds into your company yourself and are seeking to secure this lending by way of a debenture, you should approach a solicitor to prepare the documentation and filings at Companies House on your behalf.
What are the advantages of debentures?
Ultimately banks and lenders will only lend relatively limited sums without security. The primary advantage of a debenture is that it allows the company to seek greater funding level as the lenders’ exposure is secured over the company’s assets.
What are the disadvantages of debentures?
If the company fails to maintain repayments to its lender, the lender has a number of powers depending on the nature of its security, but usually it will have the power to:
- Take possession of the assets over which it has security, remove these from their location and sell them.
- Place the company into formal insolvency proceedings.
- Offset liabilities against cash funds held in the company’s accounts
This is different to unsecured facilities, where the lender does not have any ability to take control of the company / its assets.
Are debentures safe?
Debentures do not inherently present any risks, other than in the event of a default. However, it is important to ensure that a debenture is reviewed by solicitor acting for the company before it is agreed, to ensure that there are no unreasonable terms and that the terms of the debenture are fully understood, to avoid future risk.
It should be noted that in the event of a default, the lender is more likely than not to take steps to preserve their position and will explore all avenues to facilitate a recovery of their lending.
Is a debenture a loan?
A debenture is not a loan, but is a type of security granted in respect of lending. The lending can be in the form of a loan, but it can also take other forms, such as an overdraft facility or an invoice finance facility.
Is a debenture an asset?
No, a debenture is not an asset. The asset is the funds lent under the debenture and the debenture itself is merely a document detailing how those funds should be repaid and providing the lender with recovery powers in the event of a default.
Is a debenture a legal document?
A debenture is a legal document and must be filed at Companies house as a matter of public record. It is therefore important that any debenture is reviewed and advice is taken from a solicitor prior to entering into a debenture.
What is the difference between debenture and shares?
A debenture is a document which provides a lender security over asset of the company in exchange for the introduction of funding to the company.
Shares represent the ownership of the company, and entitle the shareholders to dividends from the company’s trading profits. If you hold sufficient shares, you are empowered to take steps in line with the company’s articles and memorandum of association to influence the board and the composition of the company’s board, but unlike a debenture holder you cannot exercise direct control over the company’s assets.
What is the difference between debenture and loan?
The debenture itself is not the loan, but it is the security document that accompanies the lending. A loan without a debenture, or alternative form of security, is an unsecured loan which usually means the lender has no ability to take control of the company’s assets.
A loan secured by a debenture or other document is a secured loan and the debenture created to provide the security for the loan empowers the lender to take control of the company / its assets as set out in the terms of the debenture document.
Why do banks issue debentures?
Banks issue debentures as they provide the bank with powerful recovery tools in the event that a company defaults on its repayments to the bank. This ensures the bank is able to deal with the company’s assets in line with the terms of the debenture to recover, in full or in part, the money owed to the bank.
Debentures usually grant fixed and floating charges which ensure that the bank also ranks as both a fixed and floating charge creditor in an insolvency, as opposed to being an unsecured creditor.
Banks therefore issue debentures ultimately to protect themselves from losing money on loans they issue.
Do debentures expire?
Debentures do not expire, and it is not unusual for them to remain on a company’s records at Companies House when the loan is repaid.
However, whilst certain rights within the debenture may be lost if the lending is repaid in full – for example, the company sells its fixed charge property, and settles the lend in full, leaving no debt but also no fixed charge assets over which the debenture could be used – certain rights can persist if a company were to enter into liquidation as debentures usually include an “all monies clause” which ensures that all monies due to the lender are secured under the debenture.
In practice, you may settle a loan but still utilise the company’s overdraft, therefore the debenture would still be effective over the overdraft.
Are debentures outside liabilities?
Debentures are a mechanism through which specific liabilities are secured. These liabilities will therefore rank as secured either by means of a fixed charge or floating charge when considering the company’s liabilities as a whole, but would still be treated as part of the company’s liabilities and dealt within its financial reporting, such as annual accounts.
Are debentures long-term debt?
Debentures themselves are not long-term debts.
They can be used to secure both short- and long-term lending.
What do debenture holders get?
Assuming that the company repays the lender on time and ultimately in full, the primary benefit which a debenture provides for the lender is peace of mind that the funds they have advanced can be recovered at least in part should the company default on its obligations.
However, if the company does default on its obligations, it is likely the lender will be empowered to:
- Take possession of the assets over which it has security, remove these from their location and sell them.
- Place the company into formal insolvency proceedings.
- Offset liabilities against cash funds held in the company’s accounts
These rights therefore give the lender comfort that they can advance significant funds with the knowledge that should the company default on its repayments the lender has the formal powers needed to recover the funds advanced.
For further information and impartial advice, feel free to give us a call on 0113 242 0808 or e-mail advice@chamberlain-co.co.uk