What Does the Term “Debentures” Mean in Accounting
What Is Debenture?
A debenture is a written loan agreement that is recorded at Companies House between a borrower and a lender. It provides the lender with assurance that the borrower’s assets are secure.
A bank, factoring business, or invoice discounter will typically employ a debenture to secure their loans. A debenture can only be issued to a limited company or a limited liability partnership; it cannot be issued to a single trader or a regular partnership.
A director who has advanced or lent money to their own company could secure the transaction with a debenture. A debenture can also be taken by a private lender.
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What distinguishes a debenture from a regular loan agreement?
A debenture provides a lender with greater security than a conventional loan agreement. If the borrower declares bankruptcy, the “debenture holder” (lender) receives payment before other creditors. It means that if something goes wrong, consumers will have a better chance of getting their money back.
The asset secured by the debenture is ‘protected’ from other creditors by the debenture. If the company defaults or goes into liquidation, the lender can confiscate those assets.
Based on how well the business is doing and its future prospects, a conventional unsecured lender will determine how likely they are to be repaid. They are more likely to offer a loan if the odds of repayment are good.
Who can register a debenture?
Debentures can only be issued by limited corporations or limited liability partnerships, as well as their lenders, because they must be registered with Companies House.
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When do you need a debenture?
A lender will always want a debenture if you are engaging into a full-book invoice finance facility. It ensures that your funder is able to demand remuneration from you if your customer ceases to trade and you default on your facility as a result. This puts it ahead of other unsecured creditors in terms of repayment (or, put simply, other people who owe you money).
For invoices up to £50,000, no debenture or personal guarantee is required for spot or selective invoice factoring.
Due to the public nature of debentures listed at Companies House, even your confidential invoice discounting service will be public knowledge if any of your customers conduct a search of your company on the Companies House website.
For construction companies with invoices above £50,000, debentures are always necessary. This is related to the industry’s nature, as well as the higher incidence of enterprises closing or ceasing to operate. Even if you’re at a spot factoring facility, this applies.
Types of debenture
Secured Although there is such a thing as a “unsecured debenture,” they are extremely uncommon in UK company. They rely completely on a company’s creditworthiness, and if the company fails, funders will have to wait in line with other creditors for payment. Because there is a bigger risk without security, a personal guarantee is normally required, and interest rates are higher. Redeemable This type is easy to remember because it is essentially a fixed-term loan. So, rather than invoice financing, this type pertains to circumstances where you take out a business loan. The borrower is legally obligated to repay the lender by a specified date, either in full or in instalments, as specified in the loan agreement. As a result, it must be’redeemed’ by the agreed-upon deadline. Irredeemable As you might expect, this is the polar opposite of a redeemable debenture. There is no specified end date for repayments, which implies that the company will continue to borrow and pay until it is unable to make payments. A famous example of an irredeemable type is a commercial overdraft.
Types of debenture charge
When the asset utilised in a debenture is property, you will normally be charged this fee. Because the funder has control over the asset’s use, you can’t sell it without their approval. The funder receives any proceeds from such a transaction. Alternatively, funds can be used to purchase a new asset that will eventually replace the old one, with the funder placing a fixed charge against it.Floating A floating charge, unlike a fixed fee, stands above the assets it applies to, allowing you to use them routinely in the course of business. The floating charge can be applied to a wide range of assets, including raw commodities, building fittings, and even the company’s intellectual property. You can even move or sell these assets in the normal course of business, as the charge will only become fixed when crystallisation events occur, allowing you to determine how you deal with them.
Should you use debentures to raise funds?
If you’re having trouble getting a traditional loan but have assets, debentures could help you receive the money you need. This means that any items pledged as security may be lost, and you may be locked with an asset until the loan is returned, even if you need to upgrade.
FURTHER READING: What Does the Term “Overheads” Mean in Accounting