A floating charge is a type of security interest used in business loans. It allows a lender to secure their debt against a borrower’s assets that can change over time, like stock, inventory, or accounts receivable. Unlike a fixed charge, a floating charge doesn’t tie to a specific asset when the agreement is made.
How Does a Floating Charge Work?
When a company takes a loan, they might offer a floating charge as security. The borrower can continue using, selling, or trading the assets covered under the charge during regular business operations. If the company defaults on the loan or goes into liquidation, the floating charge “crystallizes,” meaning it converts into a fixed charge and locks onto the assets available at that time.
Why Are Floating Charges Used?
Floating charges provide flexibility to businesses. They allow companies to borrow money without restricting their ability to manage assets like stock or cash flow. For lenders, a floating charge offers security over a wide range of assets without needing to specify each one in advance.
Examples of Assets Covered by a Floating Charge
- Inventory or stock
- Accounts receivable (money owed to the business)
- Cash in the bank
- Equipment and machinery that are not otherwise secured
Key Differences Between Fixed and Floating Charges
| Fixed Charge | Floating Charge |
|---|---|
| Secures a specific asset | Covers assets that can change |
| Cannot be sold without consent | Assets can be used or traded freely |
| Crystallization doesn’t apply | Crystallizes on default or liquidation |
When Does a Floating Charge Crystallize?
A floating charge crystallizes when:
- The borrower defaults on the loan.
- The company enters administration or liquidation.
- A specific event outlined in the loan agreement occurs.
Once crystallized, the lender gains control of the secured assets to recover the loan amount.
Advantages and Disadvantages
For Borrowers:
Advantages:
- Provides flexibility to manage and trade assets.
- Helps secure financing without restrictive conditions.
Disadvantages:
- Increases financial risk during liquidation as secured creditors have priority.
For Lenders:
Advantages:
- Covers a wide range of assets.
- Automatically crystallizes during specific events.
Disadvantages:
- Lower priority than fixed charges in repayment hierarchy.