What is a debenture?

If you take out a loan, you might have to sign a debenture. In the UK, the term 'debenture' refers to a secured loan agreement between a lender and you, the borrowing business. As a definition, a debenture is a tool used to define the conditions of the loan, such as how a business’ assets will be used as security, how much you’re borrowing and the agreed interest rate.

If that's still unclear, don't worry. Debentures are often misunderstood. In this guide we’ll unpack exactly what they are and the different types that exist. For now, just remember that a debenture is a tool used to define the specifics of a loan, rather than being an actual financial product itself.

How do debentures work?

A debenture means that if you default on your loan your lender will be able to claim against assets owned by your business, like laptops, property or machinery (but not your personal assets). In technical terms the lender ‘places a charge against your business assets’ – but it doesn’t actually cost you anything, it’s a legal ‘charge’.

Once you and the lender have agreed on the details of the loan and signed the debenture, the lender needs to file it at Companies House within 21 days. If they don’t do this and your business goes under, the lender would only have as much claim to what's owed as any other unpaid unsecured creditor.

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

Debentures come in many different shapes and sizes, one important variation that you'll need to understand before signing one is the difference between 'fixed' and 'floating'. These differences will determine how your loan will be secured – whether against a fixed asset such as your car or your business premises, or against a floating asset such as your inventory.

Fixed charge debentures

If you and your lender agree to a fixed charge debenture, it means the loan is secured against a specific asset such as your car, a piece of equipment or your business property. If you fail to pay back your loan, the lender has the right to take ownership of that asset in order to settle the outstanding loan balance.

With this kind of debenture, the lender may not allow you to sell whatever your loan is secured against, which could limit the way you operate your business until you’ve paid it off.

Floating charge debentures

Alternatively, you and your lender could agree on a floating charge debenture. With this type, your loan is not secured against a particular fixed asset but against an asset with a variable (but sufficient) value, for example your inventory. Even though the value of your inventory may change over the duration of the loan, the lender will have agreed that its value is high enough to act as security for the amount you have borrowed.

This kind of debenture leaves you free to trade and buy and sell stock as normal, despite the fact that the lender has your inventory as security. Once you pay off your loan, you’ll regain full control again.

Example of debenture

You run a retail store and want to borrow a large sum of money from your bank to open a new shop. You plan to use your current premises as security against the loan.

You and the lender sign a fixed charge debenture which details the specifics of the loan, including the amount, interest rate, term length and the fact that the loan is secured against the business’ original premises.

If you pay back the loan according to the debenture terms, then no further action is taken. However, if your business goes into liquidation because you’re unable to pay your debts, the debenture would ensure that the lender is repaid before any other creditors.

Other types of debentures

On top of fixed and floating charge debentures, there are a number of other types of debentures that you might come across:

Secured debentures If you're in the UK, you're most likely to come across secured debentures. As above, this means the lender leverages a borrower's assets to provide security against the loan. If there is a default in repayment then the asset will be sold to pay off the debt.

Unsecured debentures Unsecured debentures, also known as ‘naked’ debentures, are not secured by any charge against the borrower's assets. It’s rare to come across unsecured debentures in the UK business environment.

Redeemable debentures Some debentures are redeemable, others are irredeemable. The former means that on a specific and agreed date, the borrower is legally bound to repay the debenture holder, or lender. This can be done in one lump sum or in instalments over an agreed period of time. An example of a redeemable debenture is a fixed term loan.

Irredeemable debentures On the other hand there are irredeemable debentures, which are also known as perpetual debentures. Under this kind of agreement there is no specific time of redemption, which means they continue until a company goes into the liquidation process. An example of this could be a business bank overdraft.

More on loan security types:

• Personal guarantees
• Letters of credit