Floating Charge

A floating charge is a type of Security a company provides to a Lender, typically in exchange for a loan or line of credit. Think of it as a financial safety net cast over a whole class of the company's assets rather than a single, specific item. Unlike a Fixed Charge (like a mortgage on a building), a floating charge hovers over a pool of assets that constantly changes in the normal course of business. This pool often includes things like Inventory, raw materials, and Accounts Receivable (money owed by customers). The key feature is that the company, the Borrower, can continue to buy, sell, and use these assets without seeking the lender's permission for every transaction. This flexibility is vital for a company's daily operations, but it comes with a crucial string attached for the lender.

Imagine a cloud hovering over a company's warehouse and its book of customer invoices. The cloud represents the floating charge. Inside the warehouse, boxes of products (inventory) are constantly moving in and out. In the office, new invoices are created and old ones are paid off. The cloud doesn't care about any single box or invoice; it simply covers whatever is in that class of assets at any given moment. The business can operate freely beneath this cloud, turning over its stock and collecting payments as usual. The lender is comfortable because they know their security—the cloud—is always there, covering a substantial portion of the company's current assets.

The “floating” nature of the charge ends upon a specific trigger event. This process is known as Crystallization. At this moment, the metaphorical cloud bursts, and the charge instantly “fixes” or latches onto the specific assets that exist within that class at that exact time. The company can no longer deal with these assets freely. Trigger events for crystallization typically include:

• Default: The company fails to make its loan payments.
• Insolvency: The company enters into Insolvency or Liquidation.
• Breach of Agreement: The company violates a key term of its loan agreement (the Debenture).

Once crystallized, the charge effectively becomes a fixed charge. The lender, now a Secured Creditor, can seize and sell these assets to recover the money they are owed.

Understanding the difference is crucial for sniffing out risk on a company's Balance Sheet.

• Fixed Charge
  • What it covers: A specific, identifiable, and long-term Asset (e.g., land, a factory, a key piece of machinery).
  • Company's control: The company cannot sell or dispose of the asset without the lender's express permission.
  • Analogy: A home mortgage. You can't sell your house without the bank's involvement.
• Floating Charge
  • What it covers: A class of circulating or changing assets (e.g., all stock, all trade debtors).
  • Company's control: The company can freely buy, sell, and use the assets in the ordinary course of business, right up until crystallization.
  • Analogy: A security net over a pile of ever-changing goods in a warehouse.

For a value investor, analyzing a company's Debt structure isn't just about the numbers; it's about understanding who has claims on the company's assets if things go sour. This is a core part of Due Diligence.

When a company goes bust, there's a strict hierarchy for who gets paid back from the sale of its assets. Shareholders are last in line.

1. 1. Fixed Charge Holders: Get paid first from the sale of the specific asset their charge is on.
2. 2. Preferential Creditors: Certain creditors, like employees owed wages, get paid next (rules vary by country).
3. 3. Floating Charge Holders: They get paid from the proceeds of the assets their charge has crystallized over, but only after the fixed charge and preferential creditors are satisfied.
4. 4. Unsecured Creditors: Suppliers, customers, and bondholders with no security get what's left.
5. 5. Shareholders: They receive anything that remains, which is often nothing.

A company heavily reliant on financing secured by floating charges is signalling a higher level of risk. It means that a significant portion of its liquid assets are already promised to lenders. If the business stumbles, there will be very little value left for other creditors, let alone shareholders. When you calculate a company's Liquidation Value to determine your Margin of Safety, you must account for these charges. The presence of a floating charge dramatically reduces the “real” asset backing available to you as an equity owner. Always dig into the notes of financial statements to uncover the existence and extent of these securities. A clean balance sheet, free from such encumbrances, is often a hallmark of a more resilient and financially conservative company—exactly the kind a value investor loves to find.