Fixed or floating charge debentures

A debenture is a tool used to provide peace of mind for lenders when you take out a loan. It is effectively a secured loan agreement held by Companies House, wherein the conditions of the loan are detailed, for example how company assets will be used as security and the agreed interest rate. They allow lenders to secure repayments, even in the case of a default. There are two main types of debenture: fixed and floating charge, which we will cover in this article.

What is a fixed charge debenture?

In the case of fixed charge debentures, the lender retains full control over the borrower's assets as security. If the company wants to sell this asset, they will have to get the lender’s permission or first pay off any outstanding debt. Hence, a fixed charge debenture ranks ahead of unsecured creditors in the case of insolvency. More often than not fixed-charge debentures are used by business owners for their short-term borrowing needs, where assets such as plant and machinery are put forward as collateral for the loan. Collateral is required, in this case, as there is no other security in place against the loan.

Let’s take an example of a property development company that wants to raise capital for a new building project. To access a fixed charge debenture, the developer will need to put forward a separate house or apartment for security. The lender, in this case, would prohibit the selling of this asset until the loan is repaid in full. Once the loan is repaid, the developer will take back full control of the asset. If the developer uses a limited company to trade and the company becomes insolvent due to cash flow issues, the lender can allow the developer to sell the asset to repay the loan, alternatively, they could take control of the asset themselves and sell it to cover monies owed.

What is a floating charge debenture?

In contrast, a floating charge debenture is linked to all assets (current or future). This type of debenture gives the borrower the opportunity to continue trading with the assets in question, or to sell them. Floating charge debentures are favoured by businesses with little or no capital, allowing them to secure funds and also trade without any restrictions. Floating charges are often used for intellectual property and shares. 

The charge will only apply if the agreement that sits with the registrar of companies is breached, usually when a payment has been missed or the company has been passed over to an insolvency practitioner. Once the agreement has been broken, the floating charge crystalises and becomes a fixed charge on the assets. Henceforth, the borrower can no longer trade with these assets in the normal course of business, and cannot sell without prior permission from the lender.

Why do companies use debentures?

Business owners looking for a capital injection to cover cash flow gaps, fund an expansion, or to purchase new assets will need to compare a range of business loans to see what suits them best. To limit their exposure to risk, lenders will only offer small loans with high-interest rates if unsecured — the loan amount on offer can be worked out by using a business loan calculator. Hence, this is where a debenture comes into play as a tool that lenders can use to lower their risk exposure by using the borrower’s assets as security. In this case, better loan terms can be offered. 

How do I apply for a loan with a debenture?

Business owners can apply directly to a high street bank or lender, who will advise and recommend a range of products with set debentures. That said, more and more borrowers are now using lending platforms to quickly scan the market and get a direct quote from hundreds of separate lenders for the best possible deals. Once you have inputted your unique requirements you can set up a loan backed by a debenture that will get you the maximum amount of funding available to your business. This process can get a bit complicated.

If you intend on securing funding via a debenture, it is definitely worth speaking to a financial professional who can steer you in the right direction. It is not an area of funding that is easily understood, however, once you begin to understand the basics i.e whether you need a fixed or floating debenture you can then compare the market using a lending platform or via a financial advisor.