Debentures have become increasingly popular in recent years and are typically used as a means of securing debt. Investing in or lending to a business is never without risk, but debentures provide an element of protection for the investor/lender.

They can also be a useful tool to borrowers who would otherwise struggle to attract debt finance on reasonable commercial terms.

What is a Debenture?

A debenture is a legal agreement between an investor and a borrower, in which a loan is secured against some or all of the company’s assets. It is a form of charge, similar to a mortgage. The lender can expect to have a priority claim on the business’ assets in case of insolvency or defaults on payments of interest or capital.

In addition, a debenture awards the lender the rights of a mortgagee, giving them an element of control over the company’s assets. They must be consulted on the sale of assets outside of normal business transactions, and can require the borrower to obtain their consent before doing certain things that might change the risk profile of the investment.

If the company were to run into financial difficulty, the lender can ultimately assert their powers to appoint their own administrators to take over the business and realise the assets.

When is a debenture used?

A debenture is generally used in circumstances that may be deemed a higher risk for the lender. When investing in a business, the lender must rely on the creditworthiness and likely success of the business in order to get a return on their investment. A debenture provides a layer of protection for the investor. If things were to go wrong, the holder of a debenture takes a prior claim over company assets to any unsecured creditors, increasing the likelihood that the lender will be able to reclaim their debt if the worst were to happen.