What factors do directors need to understand
As mentioned above, this article will outline what is a debenture and the interests for both companies and investors.
What is a debenture?
A debenture refers to a document that explicitly details the terms and conditions of a loan to a company. The primary aim of a company debenture is to provide security and reassurance to the lender and usually contains a fixed and floating charge. If the business were to enter insolvency, they would recover their money ahead of unsecured creditors.
The company debenture outlines the terms and agreements between the lender and subsequent business, and is filed with the Registrar of Companies at Companies House. The debenture loan should be registered as soon as it is taken out or within 21 days of doing so.
The debentures document will specify the terms, including:
- The total amount the company has borrowed
- The interest rate applied to the debenture loan; fixed or variable according to the bank
- The amount due to be repaid and the timeframe for repayments
- Any charges secured to the loan
Charges on debentures
As mentioned above, the debentures document will also detail if there are any charges attached to the loan. A lender may choose to further protect their money by securing a fixed or floating charge to the debenture. Attaching a charge to the debenture loan also enables the lenders to move higher up the pecking order in terms of repayment, placing them above unsecured creditors.
It’s commonplace for many directors to invest their own money into the business – especially in the current economic climate – and attaching a fixed or floating charge to the debenture provides them with a degree of protection.
However directors should ensure they avoid falling fowl of the debenture being a preference or an invalid floating charge.
Fixed charges attached to a debenture involve tangible assets, such as the property, land or business premises. Should the company ever look to sell these assets, they must receive explicit consent from the debenture holder.
Floating charge assets are more flexible when compared to fixed. For instance, these assets can refer to stock. Unlike the above, the business can sell these assets without the consent of the debenture holder.
More information on fixed and floating charges can be found here.
Debentures: advantages and disadvantages
There are many advantages and disadvantages of debentures, both from the point of view of the company and investors.
Advantages for the company
Debentures provide long-term funds for the company, with the interest, generally, lower than that of the rate of unsecured lending. The funds can also boost growth and prove cost-effective when compared to other lending options.
A company debenture does not result in less control, as the debenture holders do not have voting rights over the business they are investing. Profit sharing also remains the same with the addition of a debenture loan.
Advantages for the lender
The primary advantage to debentures is the protection of lenders – particularly in the case of insolvency. Without a debenture, the loan is unsecured, meaning the lender would be placed at the bottom of the hierarchy of creditor payment. If you are positioned as an unsecured creditor, it’s unlikely you will recoup all money. However, a debenture places lenders above that of unsecured creditors.
The fixed rate interest on the debenture has to be paid before any dividends, further benefiting the lenders.
Disadvantages for the company
The interest payments for the lender – outlined in the debenture document – are obligatory. Should the company face financial difficulties, it could further contribute to their losses. In many cases, this can stunt the expansion and objectives of the business.
If the debenture has a fixed charge attached, the control of the asset is lost as the company must receive permission to sell from the lender. Therefore, there is a slight loss in management freedom / financial flexibility.
Disadvantages for the lender
Many lenders do not find debentures attractive as holders do not carry any voting rights with regards to the company. Also, interest on debentures is taxable, providing further reductions.
Ultimately, there are many things to consider with debentures, both for the company and investors. If you are currently experiencing financial difficulties, and wondering which is the best way forward for your business, our BusinessRescueExperts can provide debt management advice, and offer the best solution for your current financial situation.