The difference between loans and debenturesPublished on 26th November 2019 2019-11-26T15:46:49+00:00 - Last update on 4th July 2020 2020-07-04T20:17:27+00:00
Business finance can seem like a complicated landscape, especially when it comes to industry-specific terms such as debentures, unless you have the right support to decode the jargon.
A debenture is a type of loan, but not all loans are debentures.
Both are ways for a business to raise money from outside sources, but they operate in rather different ways - and, just to make things more complicated still, the ways these terms are used is different on both sides of the Atlantic.
In both the US and the UK, a business loan is a loan, a sum of money which is provided by a lender and which will be repaid, with interest, by the borrower - and usually over a set term (or time period) in monthly instalments.
There are essentially two types of business loan. With an Unsecured Loan, the borrower undertakes to make the repayments, and the lender will make a judgement on whether or not to lend based on their creditworthiness.
The risks to the lender that they will not be repaid are relatively high, which means that the interest charged will also be high and the amount that will be lent may be limited.
A Secured Business Loan can cost less because the risk to the lender is smaller. This is because the loan is secured on something of value. Secured in this case means that the borrower will need to put forward something as security - something that the lender will take and sell to recover their losses if the borrower does not keep up with the loan repayments. When you take out a mortgage to buy a home or a Commercial Mortgage to buy a factory, the property itself is securing the loan.
Business loans are often secured on the borrower's business premises or their home.
Transferring the risk to the borrower in this way allows the interest charged by the lender to be considerably smaller than with Unsecured Finance, and to offer larger sums.
At Rangewell, we frequently help arrange Secured Finance in the £multi-million region. All that is required is sufficient security - the value of the security provided must be greater than the value of the loan provided. So, for example, a £750,000 house could not be used as security for a £1 million loan - but it would be perfectly acceptable for a loan of £500,000.
What about debentures?
In the United States, a debenture is a loan that is backed by the full faith and credit of the issuer. This means that, in the US at least, a debenture is a type of Unsecured Loan, with the high creditworthiness of the borrower prompting the lender to make the loan. So for example, if Apple or Exxon Mobile decided to borrow, their credit is so good that any commercial bank would be happy to underwrite a loan. Technically, it is an unsecured corporate bond that companies can issue as a means of raising capital.
These instruments are, therefore, similar to what would be called a large-scale Unsecured Loan in the UK although, in practice, they would be relatively rare in British lending markets.
However, in Great Britain a debenture is a long-term security backed by specific assets.
Debentures allow UK lenders to secure loans against borrowers’ assets, and are the document that grants lenders a charge over a borrower’s assets, providing a means of collecting debt if the borrower defaults.
Debentures are commonly used by traditional lenders, such as banks, when providing high-value funding to larger companies. To register a debenture, a lender simply has to file it with Companies House. This can usually be done in a matter of days.
So while a US debenture is an Unsecured Loan, in the UK it is a Secured Loan.
With a Fixed Charge Debenture, a lender can ensure it is the first creditor to recoup any debt if a borrower defaults. In essence, it grants the lender possession and ownership of a borrower’s asset in the event of non-payment, with any subsequent sale being used to pay off the remaining debt. The most common form of fixed charge is against property. With a fixed charge, the borrower would not be able to sell the asset without the lender’s permission, and the proceeds would usually go to the lender or towards a new asset, which the lender then places a fixed charge over.
A Floating Charge Debenture is slightly different, and can be attached to all of a company’s assets, or specific classes of asset, including stock, raw materials, debtors, vehicles, fixtures and fittings, cash, and even intellectual property. It’s only when the lender enforces the debenture that the floating charge ‘crystallises’ and effectively becomes a fixed charge. In an insolvency or liquidation, a floating charge will give a lender priority over unsecured creditors when it comes to the allocation of repayments.
It is possible for a lender – or lenders – to have multiple debentures on the same borrower.
At Rangewell, we know that there are many solutions when you need to raise money for your business and that loans and debentures only represent some of the solutions available.
To raise the funding that you need for your business, simply call us. Our team of business finance experts work with you to get to know your business and understand the kind of arrangement and features that make sense for you.
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