Debt financing is a common practice in the corporate world, where companies borrow money from banks or other financial institutions to fund their business activities. When a company borrows money, it gives security to the lender in the form of a charge over its assets. There are two types of charges: fixed charges and floating charges. In this article, we will explain the differences between fixed and floating charges and their implications for corporate debt financing.
Fixed Charges
A fixed charge is a charge that is secured over specific assets of a company, such as property, machinery or equipment. The lender takes a fixed charge over these assets, which means that they have the first claim on them in the event of default. The company cannot sell or dispose of these assets without the lender's permission, as they are pledged as collateral for the loan.
Fixed charges offer greater security to lenders, as they have a higher priority in the event of insolvency. If a company defaults on its loan, the lender can sell the assets secured by the fixed charge to recover its money. However, this also means that the company has less flexibility in managing its assets, as it cannot sell or dispose of them without the lender's consent.
Floating Charges
A floating charge, on the other hand, is a charge that is secured over the assets of a company that are subject to change, such as inventory, accounts receivable or inventory. A floating charge "floats" over these assets until it crystallises, which happens when the company defaults on its loan or goes into administration.
The advantage of a floating charge is that it allows the company to use its assets freely in the ordinary course of business. The lender does not have any direct control over these assets until the charge crystallises, which gives the company greater flexibility in managing its assets.
However, the downside of a floating charge is that it offers less security to lenders than a fixed charge. If a company defaults on its loan, the lender must wait for the charge to crystallise before it can claim the assets secured by the floating charge. This means that other creditors may have a higher priority over the lender in the event of insolvency.
Implications for Corporate Debt Financing
The choice between a fixed or floating charge depends on the circumstances of each case. Companies with a high level of fixed assets may prefer a fixed charge, as it provides greater security to lenders. However, companies with a high level of inventory or accounts receivable may prefer a floating charge, as it allows them to use these assets more freely.
In practice, lenders may require both fixed and floating charges as security for their loans. This is known as a debenture, which is a document that creates a fixed and floating charge over the company's assets. The debenture sets out the terms of the loan, including the interest rate, repayment schedule and security arrangements.
In conclusion, fixed and floating charges are two types of security that lenders can take over a company's assets in corporate debt financing. Fixed charges provide greater security to lenders, but less flexibility to companies, while floating charges offer more flexibility to companies, but less security to lenders. The choice between a fixed or floating charge depends on the circumstances of each case, and lenders may require both as security for their loans.
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About the author
Sabbir Rahman is Managing Director of Langdon Capital and a Partner at Bridging Funding. He has held prior roles with Morgan Stanley, Lazard and Barclays Investment Bank. He has executed over £60 billion in notional value of transactions across financing, M&A and derivatives with global corporates, private equity funds and financial sponsor groups.
About Langdon Capital
Langdon Capital provides in-house transaction services to C-suites and Boards of publicly-listed and PE-backed businesses during the negotiation, execution and due diligence of corporate finance and capital markets transactions and senior interim resourcing solutions across finance, treasury, strategy and corporate development | contact info@langdoncap.com | visit www.langdoncap.com
About Bridging Funding
Bridging Funding is a private credit fund engaged in principal lending of commercial property bridging loans in the UK and select South-East Asian markets. We lend between £200k and £20m per transaction. As a private credit fund, our credit sanctioning process is leaner and more flexible than lenders funded by bank capital | contact sr@bridgingfunding.com | mention code “Langdon” for preferential rates | visit www.bridgingfunding.com
This is not financial advice or any offer, invitation or inducement to sell or provide financial products or services or to engage in any form of investment activity.
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