Finances are a part of every person’s everyday life.
Whether it is for your personal finances such as budgeting for the month or professional finances like getting a loan for your small business, money and finances will show up at some point in your day.
However, when you are not an expert in finances, your financial options can be intimidating, especially when you are running a business, and your livelihood relies on how much you know and how much you understand your finances.
Some of the questions you have might be about the best loans to take out for your business or what these loans even mean. You may also be wondering what a debenture is and what it can mean for your business.
What is a debenture?
In short, a debenture is a bond, but it is good to note that debentures have different definitions depending on the country that issues them.
In the United Kingdom, a debenture is a bond that is secured by company assets.
Debentures are also secured against property or other assets that are owned by the borrower. Debentures have a more specific purpose than your average bond.
These are usually issued to raise capital to help meet the expenses of an upcoming project or to pay for a business expansion.
Types of Debentures
Fixed Charge: With a fixed charge, a lender can make sure it is the first one to get any outstanding debt if a borrower defaults on a loan. It allows the lender to gain ownership or possession of the borrower’s asset if they cannot pay and any money made in a sale that may take place of the asset goes to pay off the remaining debt. A fixed charge is most commonly used against property and fixtures or machinery that might help add value to the property.
Keep in mind that with a fixed charge, the borrower will not be able to sell the lender’s asset without their permission, and the proceeds usually go to the lender or towards a new asset where a fixed charge is then added.
Floating Charge: A floating charge can be attached to all of a company’s assets or a specific class of asset like stock, intellectual property, cash, and more. The charge gets the name “floating” because of its nature.
With floating charges, assets may change over time and the borrower can move and sell assets during the normal course of business.
When the lender looks to enforce the debenture in a default situation, the floating charge will become a fixed charge.
Once that happens, the borrower will not be able to handle the assets unless they have permission from the lender.
If insolvency or liquidation is involved, a floating charge will give a lender priority over unsecured creditors when it comes to the allocation of repayments. In most insolvency procedures, a licensed insolvency practitioner would handle the allocations.
How are debentures paid?
Financing for debentures is usually long-term. They can either have a floating or a fixed-interest coupon rate return to investors and this will have a date where the debenture needs to be repaid.
Most often, when an interest payment on the debenture is due, the company will pay the interest before the shareholder dividends are paid.
When it comes to paying principal, the company that took out the debenture has two choices to pay it back: they can pay the principal in one sum or pay the principal in installments.
If you choose to pay in installments, you will have an installment plan called a debenture redemption reserve. The company will pay a set amount each year to the investor until the debenture has reached full maturity.
How do debentures affect business?
To a certain extent, debentures have a circular lifespan. Sometimes they are called revenue bonds based on their nature.
This title relates to their lifespan: they are called this because whatever institution issues them expects to repay the loans with the revenue or proceeds of the business expansion or business project the debenture helped finance.
Another important aspect is that debentures leave borrowers vulnerable to lose. They grant lenders a charge over a borrower’s assets which gives them something to collect if the borrower fails to pay the debenture back.
Debentures are a necessary means to raise money for your business, but they do not come without their cons.
The main con with debentures is that you need to have to offer assets as security.
The other con is that some lenders will not lend about a certain amount without a debenture so they are a necessary means to an end in some cases.
