Debentures and floating charges

Debentures and floating charges are directly related to insolvency: if a business borrows money but the worst happens and it becomes insolvent, what happens with the money owed? It’s a rather technical area, but important to know about if you’re considering using a financial agreement that uses a debenture or a floating charge.

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Debentures and floating charges

What is a floating charge debenture?

A debenture is a document put in place when a loan is granted to protect the company or individual which lends money to a business. It gives lenders a priority position in the list of companies or people who’ll get their payment if a company becomes insolvent.

The debenture defines the terms of the loan agreement, covering the total loan amount, interest rate, repayment amount and any other charges that should be included. It should be filed with the Registrar of Companies at Companies House within 21 days of the loan being taken out.

Unfortunately, if it’s not filed, the debenture can be ignored by the business administrator meaning the lender would have to join the list of unsecured creditors.

Is a debenture a floating charge?

A floating charge is a charge over a particular class of assets, such as inventory or trade receivables. It isn’t possible to identify specific individual assets like this, as they change day to day as a company runs its business. However, the moment a business defaults, the charge will attach to all assets of that class that exist on that date; they’ll be seized and sold as soon as possible. Often, both a fixed and floating charge will be granted on the same loan

What is a fixed charge?

A fixed charge on a debenture offers lenders extra protection for their money if the borrower’s business becomes insolvent. The extra protection comes from material assets like machinery, property and land, and these assets cannot be sold on without the insolvent company either repaying the loan or getting consent from the lender.

The difference between fixed interest and floating charges

A fixed charge essentially stops the borrower from selling their assets without repaying the lender first, whereas a floating charge allows businesses to carry on buying or selling their assets. Floating charges aren’t held against specific assets within the business but cover a group- or even all of the business assets.

Because floating charges are applied to assets that are more naturally bought and sold through day-to-day business, the groups of assets which often have the floating charge applied to them include:

  • Raw materials

  • Stock

  • Trade receivables

  • Part-built products

  • Cash

You might hear about floating charges ‘crystalising’ which is what happens when a business enters insolvency. Before insolvency happens the floating charge applies abstractly to groups of assets; during insolvency, the charge is applied to specific assets and so becomes clearly defined — it’s crystalised.

It’s important to note that if a fixed charge and a floating charge are applied to the same asset, the fixed charge takes priority during insolvency. You may also hear terms like ‘first charge’, ‘second charge’ etc. which refer to the order of priority given to each charge.

What are debentures and charges for?

A debenture can be a cost-effective way for a business to get long-term funding. Without the debenture, the lender could receive less money during insolvency than they’re due and would likely want to increase their other costs (like interest rates) on the loan to account for that increased risk.

Debentures vs personal guarantees

Here at Funding Options, all of the debentures and charges we’ve looked at use various methods to tie a borrowed amount to a specific business asset (or a floating group of assets). Therefore, you’d probably consider these to be secured lending.

For various unsecured products, lenders will use personal guarantees instead of debentures or charges to help mitigate their risk. Personal guarantees essentially mean the business owner is personally responsible for paying back the loan if the business is unable to do so.

In more complex cases, or cases where the business is borrowing a large sum of money, lenders might choose to use a combination of debentures, charges, and personal guarantees — so the finance is both secured and unsecured. This type of arrangement might be called asset-based lending.

Whether it’s secured or unsecured, debentures or personal guarantees, these arrangements are created specifically for lenders to give them an additional option for getting their money back if things go wrong and the business they’ve lent to can’t pay.

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