Companies that need money for projects or general operations have the option of offering bonds to the public. The bonds are like IOUs for a large number of small loans, which the issuing company pays back on a specified date with or without interest. There are both advantages and disadvantages to generating capital using this form of debt security.
No Ownership Stake
Bonds, unlike stocks, do not include an ownership stake in the company. When you issue a bond, your current shareholders keep whatever ownership equity they have in the company. They therefore keep the control of the business. This is a good thing if you don't want to change who is running the company or the general operations of the business.
When you issue a bond, you tell the bondholder exactly when he can cash in the bond. You also set the rate of interest you will pay. Thus, the repayment of the loans obtained via bonds is very predictable. This enables you to estimate what the company's financial obligations will be at a specific point to some degree, which makes planning for operations easier.
No Profit Stake
When you issue a bond, you are not obligated to share the profits generated by using the loaned funds. You only have to pay the face value of the bond, plus whatever interest you've set. If your company does well, this means you can get a very large return for the money you have to pay out.
You must pay interest on any bonds you issue that have a designated interest rate. However, you can deduct the interest payments on your company income tax return. Overall, this means that bonds have a lower after-tax cost and don't cost you as much to offer.
Should your company get into rough financial water and you're forced into bankruptcy, you pay bondholders first, because they are creditors. This means that bonds are less risky for the investor compared to stock.
When you issue bonds, the only thing you provide your bondholder with is a promise for repayment. With stock, you provide ownership. Thus, when you issue bonds, you can't avoid increasing your overall debt and taking on debt risk. You must pay the interest even in years where the company is struggling, and when the bond matures, you have to pay the full face value. The inability to meet this obligation can force you into bankruptcy, which has its own host of negative ramifications.
When you offer bonds and increase your debt risk, the public may not perceive the acquisition of debt positively. Because investors generally like to see that a company has some cash or cash equivalents on hand, they might see your actions as a sign that the company is strapped for cash, particularly if your company does not have a good bond rating. People may walk away not only from the bonds, but from stocks and your products, as well.
In some cases, in order to provide some assurance to investors, you might have to offer some of the business's assets as collateral for the bonds. If you don't pay the interest or the face value of the bonds as agreed, you may lose those assets. This may make it hard to continue to do business and ultimately may mean the company has to fold.
- Collateral Trust Bonds - Debt Securities Basics | LectLaw.com
- Corporate Bonds | Investor.gov
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Wanda Thibodeaux is a freelance writer and editor based in Eagan, Minn. She has been published in both print and Web publications and has written on everything from fly fishing to parenting. She currently works through her business website, Takingdictation.com, which functions globally and welcomes new clients.