You have two main options if you want to secure funding for your business. You can either take on debt, and repay the amount you borrow or offer a stake in your company in exchange for the amount you want to raise. If you're comfortable with the idea of the former choice, one of the options that could be available to you is a redeemable debenture.
The reasons for seeking external support will be unique to your business. But one factor that is ever-present is the need to make sure you know what a specific type of funding is – and how it works. This information can help you make the right funding decision for your company. That's the decision with which we aim to help you in this guide to redeemable debentures as a finance solution.
Our guide to debentures will explain the basics of this funding solution. To provide a refresher, however, a debenture is not itself a source of funding. Instead, it's a document that highlights the details of the funding you receive from a lender, including interest rates, payment dates and assets offered as security.
So what makes a debenture 'redeemable'?
The term 'redeemable debenture' aims to set them apart from ones that are 'irredeemable'. In this respect, 'redeemable' means that you must pay back what you owe by a specific date. You also have to pay any interest accrued. In comparison, 'irredeemable' means there is no date by which you need to pay back the lender what you owe.
You may come across what are called redeemable non-convertible debentures. There is nothing different or out of the ordinary about these debentures. Your loan will still have a set date on which it will mature. All that 'non-convertible' means is that a loan won't be turned into equity shares – something which could then make it an example of equity financing.
This scenario simply guarantees that the loan continues to be a debt instrument. And it still needs to be repaid by the specified date.
Unless the terms of a redeemable debenture say otherwise, you can use the funding for almost any business reason. This is very much a long-term commercial finance solution, so that must be part of your thinking when you come to apply. It does mean, however, that there is a range of things for which you can use the funding:
− Get the latest technology to improve performance or upgrade your equipment.
− Secure a new location, warehouse or production plant to increase your output.
− Add more products to your offer or expand the volumes you currently provide.
− Take your business into new markets, whether that’s products or countries.
It's not a good idea to use a redeemable debenture as a short-term fix for things like cash-flow concerns. In the same vein, other options could be more suitable if you don't need to borrow a huge amount of money. In such cases, a business loan or cash advance may be more relevant.
The first step is to find a lender who can provide the finance you need. Once you do this, you'll have to agree to the terms of your loan. This covers the total amount you'll repay, the date on which it's due and the interest rate. You'll also need to provide the necessary collateral if it's a secured debenture – which most in the UK are.
Redeemable debentures must be registered with Companies House upon signing. This must be done within 21 days, though the lender is usually responsible for making this happen. In rare cases, however, it can be done by you as the borrower.
The point of registering the debenture is so that the lender becomes a priority creditor if you go out of business before the maturity date.
Once the redeemable debenture is in place, you must stick to the terms to avoid any penalties. The most important thing is that you can pay back what you owe when the lender 'redeems' it on the date outlined in the agreement. If not, you'll lose control of the assets against which you secured the loan. And that could be anything from critical machinery to your place of business.
− You need a loan to help cover the cost of a new factory.
− You find a lender who can provide it with the security you're willing to offer.
− Both you and the lender sign a debenture, which states when the loan needs to be paid back – along with the interest rates involved. It is registered with Companies House.
− When you reach the maturity date of the loan, the lender 'redeems' what is owed under the terms of the agreed debenture.
The pros and cons of any business finance solution can give you a much clearer idea if it's going to be right for you. For all the benefits you may get out of it, the pitfalls may create more issues than it's worth. So, let's consider the ups and downs of a redeemable debenture.
− You have no flexibility. In comparison with other forms of funding, it's impossible to change the terms of a debenture once it's registered. A bank, meanwhile, might be able to alter a payment schedule if your circumstances change.
− Any security you offer will be at risk if the worst happens and you default on the loan.
− For fixed charge debentures, the assets used to secure the loan can't be sold until your maturity date. It means that you may miss future opportunities, e.g. the chance to upgrade to a new system or move to the ideal premises.
A lender can only take out a debenture on a limited company or a limited liability partnership. For sole traders and regular partnerships, this means that you won't be able to get funding with a redeemable debenture. If you are eligible, you'll then need to find a lender willing to the total amount you're looking for – and have the collateral to secure the loan.
Now you have a clearer idea of what a redeemable debenture is, you're in a better position to decide if it's the right option for your business. And sometimes the answer may well be ‘no, it’s not’. If that's the conclusion you reach, no worries. There are plenty of alternative business finance solutions out there for you. It's something in which we specialise here at Nucleus.
For SMEs in need of support, we can provide funding worth between £3,000 and £50m across our product range. It all begins with a free, no-obligation consultation. This lets us understand your goals, challenges and ambitions. We'll then give you a tailored funding quote. Does that sound good? Get in touch with our team of business finance experts today to learn more.
4 May, 2022