The Pros and Cons of Company Debentures

Debentures are often used by companies to raise capital, and they typically have a maturity date of more than one year.

When a company issues a debenture, it is agreeing to pay back the principal amount of the debt plus interest at an agreed-upon rate. Debentures can be secured or unsecured, and they may be traded on the secondary market.

Companies that issue debentures typically do so in order to raise capital for expansion or other business initiatives. However, debentures can also be used to finance the purchase of assets or to refinance existing debt.

In general, debentures are a type of debt instrument that can provide companies with the funds they need to grow and expand their businesses

What is a debenture?

A debenture in the UK is a type of debt instrument that is not secured by physical assets, but rather by the general creditworthiness of the issuer. Debentures are typically issued by large companies in order to raise capital, and they typically have a term of five years or more. Interest on debentures is usually paid at a fixed rate, and the principal is repaid at maturity.

Because debentures are not backed by collateral, they represent a higher risk for investors than secured loans. However, they also offer higher returns, which makes them an attractive option for many investors.

What is the purpose of a debenture?

The purpose of a debenture is to allow a lender security over the borrower’s assets. Most often, a debenture is used by a bank to take security of their loans. A debenture loan can only be taken on by a limited company or limited liability partnership, it cannot be taken over by a sole trader or standard partnership.

When taking out a debenture loan such as invoice finance, the borrower will typically have to provide the lender with a list of their assets as well as an agreement that the lender can take possession of these assets if the loan is not repaid. Debenture loans are often seen as high risk because the borrower is essentially giving up ownership of their assets, but they can also be advantageous because they tend to have lower interest rates than other types of loans.

Example of a debenture

An example of a debenture is you run an online business in which you sell health care products, and you wish to borrow money from the bank for expansion. You will use you business premises as security for the loan.

You and the lender both sign a debenture. This will loan specifics will be detailed as such:

• The amount
• The term length
• The interest amount
• The fact that the loan is secured against your business’ original premises.

If all loan repayments are met in accordance with the debenture terms, no further action will be taken. Should your company hit a down turn and the business goes into liquidation and you are unable to pay the balance outstanding, as the lender holds a debenture this will ensure that they are repaid before any other creditors.

How do I know if a debenture is registered against my company?

In order for a debenture to be registered against a company, a director of the company must have signed it with the lender. Once signed it is then forwarded onto Companies House and lodged.

You can check for free at Companies House to see if any debentures have been filed against your company. Once you have found the company you wish to check, it will detail any debentures that are charged against a company in order of date.

If a high street bank or other business lender have issued the debenture, they would have requested that you sign a personal guarantee. Before signing the guarantee the lender will advise you to seek independent legal advice.

Can one or more debentures be registered against a company?

Yes a company can have one or more debentures can be registered against a company. Debentures will rank in order of the date created, unless one lender has given another a deed of priority. If you find a previous lender who has been repaid but has not removed their debenture, you should ask them to remove it.

Sometimes lenders may sign a negative pledge, which is an agreement not to give a debenture to someone else. By understanding how debentures work, you can decide whether they are the right form of security for you.

Types of debenture charge

Company directors need to be aware of the different types of debenture or charge these are:

Fixed charge

A fixed charge debenture is a type of loan that is secured against a specific asset. This means that if you default on the loan, the lender can take possession of the asset and sell it in order to repaid the loan. Fixed charge debentures are often used by businesses to raise capital, as they provide borrowers with a relatively low-risk way to access funds. This type of loan can also be used by individuals, provided that they have an asset that can be used as collateral.

Floating charge

Floating charge debentures are a type of business loan that can be used to finance a variety of purposes, from working capital to equipment purchases. Unlike other types of loans, floating charge debentures are not secured against a particular fixed asset. Instead, they are secured against an asset with a variable value, such as inventory. This means that if your business is unable to repay the loan, the lender can seize and sell your inventory in order to recoup their losses.

While this may seem like a risky proposition, floating charge debentures can be an attractive option for businesses that lack the collateral necessary to secure a traditional loan. In addition, the interest rates on floating charge debentures are typically lower than those of other types of loans. As a result, they can be a helpful tool for businesses looking to save money on their financing costs.

Multiple debentures

It is possible for a lender to have multiple debentures on the same borrower. For example, a bank may issue a fixed-rate debenture and a floating-rate debenture to the same borrower. Or, a borrower may have multiple debentures with different lenders. In either case, the presence of multiple debentures can potentially increase the risk for the lender.

When a debenture is placed on a company, it typically prevents other lenders from adding their own debentures without the consent of the original lender. However, in situations where there are multiple lenders who have debentures against the same borrower’s assets, the lenders will typically agree on the priority of payments between themselves.

This agreement ensures that each lender receives their fair share of any repayments that are made by the borrower. While debentures can sometimes be complex financial instruments, they can be an effective way for lenders to protect their loans in cases where a borrower may be at risk of default.

Convertible debentures

A convertible debenture is a type of debt instrument that offers investors the ability to convert their investment into equity shares of the issuing company after a certain period of time. This type of debenture is appealing to investors because it provides them with the potential for upside if the company’s stock price increases.

For businesses, convertible debentures offer a lower interest rate than traditional debt instruments. This can be helpful when businesses are looking to increase capital without incurring a high cost of borrowing. Convertible debentures can be an attractive option for both businesses and investors.

Non-convertible debentures

Non-convertible debentures (NCDs) are a type of debt instrument that does not convert into equity in the issuing company. NCDs typically offer a higher interest rate than convertible debentures, making them a more expensive form of capital for businesses.

However, NCDs can be an attractive option for investors looking for a higher yield and less risk than stocks. For businesses, NCDs can be a useful source of financing for expansion or other capital needs. When considering NCDs, it is important to weigh the costs and benefits to determine if they are the right fit for your business.

What’s the difference between fixed debentures and floating debentures?

There are a number of differences between fixed and floating debentures, these are:

A fixed debenture loan is secured against assets and, should you fail to repay the creditor, in order to settle the outstanding loan they receive the right to take ownership of that asset.

Floating debenture loans are not secured against any fixed assets. Their security is secured over assets with variable but sufficient value, such as inventory or outstanding invoices. You will regain complete control over the assets once the loan has been repaid in full.

Further reading on fixed vs floating charges can be found here.

How do debentures work?

Debentures work by directors offering security to a lender over an asset in return for a loan, a debenture is solely a document the provides evidence that security has been granted. This allows lenders a means of collecting debt in the event that a borrower defaults.

If the borrower defaults, right to appoint an administrator to take control of the company is granted to the lender. The threat of an administrator being appointed should not be used as a collection tool by lenders by it can be enough for a company to repay the debt, or agree to the terms to repay it.

What are the risks of debentures?

Although debentures can be a useful tool for companies to raise capital, they also come with a number of risks. For one, debentures are often unsecured, meaning that they are not backed by any collateral. This makes them a high-risk investment for creditors, who may be unwilling to lend money to a company if there is no asset to seizure in the event of default.

Additionally, debentures are often long-term debt instruments, which means that companies may have difficulty making interest payments if business conditions deteriorate. Finally, debentures may also be subject to call provisions, which allow the issuer to redeem the bonds early. This can leave investors with losses if interest rates have fallen in the meantime. As a result, debentures can be a risky investment for both companies and creditors alike.

A readily available exit mechanism for most debentures holds a company liquidation risk. If a company is in financial difficulty, this can compromise growth and may pressure some companies towards insolvency

Pros and Cons of Debentures

As with any type of financial implement a debenture comes with Pros and Cons, these are:

Pros of a debenture

• Profit sharing remains in the same proportion as the control of the company by existing shareholders is not reduced.
• Debentures can help business growth with long term funding.
• Financial protection for directors, debentures offer reassurance regards their personal funds.
• In insolvency a debentures ensure a higher position in the list of creditors who need repaid.

Cons of a debenture

• The borrower  has no flexibility and their company in their obligation to make interest payments on the debenture.
• By holding a debenture the lender loses their right to take a share of the company profits.
• Restrictions placed on a company by securing the debenture with an asset/s removed the management’s freedom to control or use the assets at will

This guides aim was to help you to understand debentures and how they could affect your business.

Business insolvency Helpline offer friendly and expert business debt advice tailored to your specific needs. Feel free to contact us today if you are worried about a debenture or your business finances.

Conclusion

Company debentures are a type of long-term debt instrument that is issued by a company to raise capital. They allow the company to borrow money from investors in exchange for a fixed rate of interest and the promise to pay back the principal amount at a later date. There are both advantages and disadvantages to using company debentures as a source of financing.

One of the main advantages of company debentures is that they allow a company to raise large amounts of capital without giving up equity or control. This can be especially appealing to small or new companies that may not have a strong track record or collateral to offer in exchange for a loan. Debentures also offer a predictable source of long-term financing, as the terms of the debenture are fixed in advance and do not fluctuate with changes in market conditions.

However, there are also some disadvantages to using company debentures. One potential disadvantage is that the company must pay a fixed rate of interest on the debentures, which can be a significant burden if market interest rates rise. Additionally, if the company is unable to make the required payments on the debentures, it may default on the loan and risk damaging its credit rating. In such cases, the company may be forced to negotiate with its creditors or restructure its debt, which can be time-consuming and costly.

Overall, the decision to use company debentures as a source of financing will depend on the specific needs and circumstances of the company. While debentures can offer a convenient and flexible way to raise capital, they also come with certain risks and obligations that companies should carefully consider before committing to this type of financing.