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Debentures are one of the more complex terms you’ll encounter when it comes to business finance. So what are they and how do they work?

What is a debenture?

A debenture is an agreement between a business and its lender enabling the lender to put a charge on the business’s assets. Debentures are a feature of secured lending, where assets are put up as collateral. This gives lenders the security of knowing they’ll be able to recover the money they’re owed if the business can’t repay the loan.

The term debenture essentially refers to the document itself, which is filed with Companies House.

What are the types of debenture?

Debentures come in two main types, both of which are subtly different:

Fixed charge debenture (sometimes called a legal charge)

A fixed charge debenture refers to a charge put against a fixed asset which isn’t likely to change. The fixed assets covered by such a debenture include property, fixtures, machinery or vehicles.

If an asset is covered by a fixed charge debenture, the borrower can’t sell it without the lender’s permission first. If they get permission, the money from the sale would normally either go to the lender or go towards a new asset which would then be put under another charge.

Floating charge debenture

This kind of debenture is only different in that the assets covered by the charge don’t need to be fixed. This means it can include assets that change regularly as part of the business’s normal day-to-day activities – for example, stock, raw materials or cash.

If the borrower defaults on their loan, the charge is said to “crystallise” and becomes a fixed charge. In that event, the assets covered by the charge are no longer under the complete ownership of the borrower (as with a fixed charge debenture).

Priority of repayments in the event of insolvency

When a business becomes insolvent, its debtors must be paid in a certain order, and the different types of debentures have different priorities.

The order of priority is as follows:

  1. Fixed charge holders
  2. Liquidator’s fees and expenses
  3. Preferential creditors
  4. Floating charge holders
  5. Unsecured creditors
  6. Interest on unsecured debts accrued after liquidation
  7. Shareholders

Bear in mind…

Confusingly, the meaning of debenture is entirely different in the United States. In the US, a debenture is a type of unsecured corporate bond. You can read more about the US definition of debenture on Investopedia.

Where does the word come from?

“Debenture” comes from the Latin word “debentur” which means “these are owing”. This was supposedly the phrase used at the beginning of debenture documents in early times. “Debentur” in turn comes from the Latin word “dēbitum”, meaning “debt” or “obligation”.