Debentures

UK SME owners can choose from several different finance options to ease short-term cash flow concerns or support long-term growth plans. Some can be more appropriate than others when it comes to the unique needs of your business. Making sense of your options is important. A debenture, for example, can be an effective long-term solution to satisfy your finance needs.

Like any source of funding, you must be fully aware of what you’re signing up for. What does it mean to be a debenture holder? Where can you secure one from? And how much interest may be charged on the funding it provides? In this guide, we’ll explore the ins and outs of what this type of finance entails and whether it may prove to be a solution your business benefits from.

What is a debenture?

Debenture. In the grand scheme of commercial finance products, it might not be a term you’re familiar with. So, the first step is to understand exactly what we’re talking about. And we must understand the difference between the meaning of debentures in the UK and the US – because it’s slightly different and will affect how suitable it is for you.

In the US, a lender or investor can issue a debenture to a company without requiring any form of security. But that’s not the case in the UK. Here, it’s a secured business loan where a lender will provide funding against your company assets. You’ll also usually have to pay fixed rates of interest on the amount you borrow.

The term debenture actually refers to a document that sets out the existence (and conditions) of the loan in question. A debenture holder won’t take a share in the business, as the provider of equity finance would. But terms can include security they’ll recoup if you fail to pay.

The different types of debentures

If you decide to sign a debenture, one thing you must know is whether it’s a ‘fixed’ or ‘floating’ arrangement. Ultimately, the type of debenture will determine how the loan is secured against your business. Here’s a breakdown of the two main types:

• Fixed charge: As the name suggests, a fixed charge debenture loan is secured against a specific thing – perhaps a car, machine or business premises. Should payment not be made, however, the lender can claim ownership of that asset.
• Floating charge: This type of debenture as a source of finance is more flexible because it’s secured against something that can change in value. Your business inventory is one common example of this and can offer the security you need.

In addition to these types of debentures, you may also encounter redeemable or irredeemable options. The latter has no fixed time by which the loan needs to be repaid. As such, it can last for as long as your business continues to trade.

What can I use a debenture loan for?

Unless the terms outlined in your debenture specify otherwise, nothing restricts how you use the funds you raise. As a medium to long-term option, though, it’s highly unlikely to be the best for immediate cash flow concerns.

Instead, it can be an effective way to raise the capital you need for growing your business through:

−      Buying new technology and equipment to help transform your operations

−      Acquiring more premises to expand your physical footprint as a business

−      Getting more stock, new lines and diversifying your existing proposition

The features of a debenture: How it works

Do you need a long-term source of business finance? You can approach a bank, another form of lender or an investor. If they agree to loan you the amount you require, you could well be asked to sign a debenture. By doing so, you allow the lender to claim against your nominated business assets if you default on your repayment.

With all the details agreed, the debenture must then be filed at Companies House by the lender. If the lender doesn’t do this, they lose the security that you’d otherwise agreed to provide if your business stops trading before you’re able to pay back what you owe.

Two important features to note with a debenture are:

−      Interest rate: Like a conventional loan or credit card, the interest due on your debenture loan can add significantly to the cost of borrowing if you’re not aware.

−      Maturity date: This is the date on which the full amount (plus interest) must be received by the debenture holder. If not, they can claim your secured assets.

It’s rare, but some debentures can be convertible. This is a type of bond that can be converted into equity shares by a lender, essentially combining equity and debt financing in one product.

Debentures: An example

A lender agrees to loan you £50,000 to support your growth plans. The maturity date is set at 18 months from now, while the annual interest rate is 3.5%. Finally, it’s agreed that your loan will be a fixed charge – secured against a company vehicle.

As the borrower, you have to pay back the £50,000 at the end of those 18 months – plus the interest, whether that’s periodically or in total at the end. If you fail to pay on time, the lender will take ownership of your company vehicle to settle the outstanding balance.

Who can issue debentures?

In the UK, a debenture holder could be a bank or another financial institution. In some cases, it can also be a factoring company. 

Debentures: Advantages and disadvantages

No form of finance is completely risk-free. For all the upsides of getting a debenture loan, there can be some downsides to be aware of. After all, you don’t want to agree to anything that could be bad news for your business.

Advantages of debentures

• A debenture could be the most effective way to get the money you need for your business. Other options may cap the total you can borrow, but the extra security that comes with a debenture may give you access to more funds.
• You’ll get full certainty over what you must repay and when that amount is due.
• For some businesses, the concept of risking assets in return for finance might feel like an unnecessary risk. No one sets out with the aim of defaulting on a loan. But the impact of doing so could be too grim for your business to bear.
• You have little wriggle room. You must pay the interest and you must repay what’s owed by the maturity date. That can draw finances away from other areas of a business at a time when you may be under cash flow constraints or looking to grow.
• Under a fixed charge debenture, you can’t sell the assets that your loan is secured against. This can be problematic if you have a chance to raise funds by doing so.

Disadvantages of debentures

• For some businesses, the concept of risking assets in return for finance might feel like an unnecessary risk. No one sets out with the aim of defaulting on a loan. But the impact of doing so could be too grim for your business to bear.
• You have little wriggle room. You must pay the interest and you must repay what’s owed by the maturity date. That can draw finances away from other areas of a business at a time when you may be under cash flow constraints or looking to grow.
• Under a fixed charge debenture, you can’t sell the assets that your loan is secured against. This can be problematic if you have a chance to raise funds by doing so.

Can I get a debenture loan?

You may be able to get a loan with a debenture if you’re a limited company or limited liability partnership. You won’t be eligible if you’re a standard partnership or a sole trader.

Can I have more than one debenture?

Yes – your business can be subject to more than one debenture at the same time. Of course, it is crucial that you first consider whether you can meet all the obligations. If more than one debenture does apply to you, the earliest one normally takes precedence.

The alternatives to debentures

Do you need finance but don’t like the idea of risking your assets? Other options could better fit your needs. Our unsecured Cash Flow Finance is one example of the various products we offer to support SMEs across the UK.

To discuss your options, why not get in touch? Our expertise as a specialist alternative provider of commercial finance can help you discover the right solution. We’ll arrange a consultation and quote with absolutely no obligation. We’ll see what we can do to put you on the right track.