When a company needs to raise capital, it has two primary options. The first is to issue bonds. The second is to issue stock. These are two very different financial tools. Although stock can be preferable in some instances, bonds offer advantages that may make them the better choice for some companies.
A major difference between issuing bonds and issuing stocks is that bonds are debt securities while stocks are the sale of equity. When you issue stocks, you sell partial ownership in the company and give shareholders the right to participate in votes that impact the business. When you issue a bond, you don't dilute your equity in your company the way you do by dividing the ownership of the company. Instead, you keep your equity intact. That means those who already have ownership rights keep control of the company -- you essentially use someone else's funds to meet the company's needs.
When you issue stock, you pay dividends, if desired, with money on which you've already paid taxes. By contrast, even though you have to pay interest on a bond, you can deduct the interest on your company's income tax return. That means that the bonds usually are cheaper from the tax perspective.
When you offer stock, you entitle the buyer to ownership in the company until he sells his stock. The buyer has no set time at which he must do this, and in fact, some buyers don't cash in their stock within their lifetime, instead transferring ownership to someone else through vehicles such as wills when they pass away. At the same time, stockholders can sell their stock whenever they see fit, which means that ownership ratios within the company are constantly shifting and are hard to track. Conversely, when you issue stock, the date for repayment, along with the rate of interest, is set. Additionally, even though bond holders can transfer ownership, they have to contact you to have the bond reissued to someone else. This makes payment very predictable and easy to handle.
Unlike stock, bonds do not entitle the buyer to share in the company's profits. You must pay them only the face value of the bond and the accrued interest. This means that your stockholders are able to keep a larger amount of the money the company earns using the funds.
When you issue bonds, the bondholders become your creditors. If you must file for bankruptcy, creditors receive payments before shareholders do. Some investors may see this as making bonds less risky than stocks and therefore may be more willing to purchase them.
- St. Michael's College: Risk and Return and the Financing Decision: Bonds vs. Stock
- Better Investing Community; Choices in Raising Capital; Virginia B. Morris; 2011
- Economicstextbook.net: Bonds
- Office of Investor Education and Advocacy. "Bonds." Accessed May 24, 2020.
- Securities and Exchange Commission. "Bankruptcy: What Happens When Public Companies Go Bankrupt." Accessed May 24, 2020.
- Fidelity. "Bond Ratings." Accessed May 24, 2020.
- Office of Investor Education and Advocacy. "Stocks." Accessed May 24, 2020.
- Fidelity. "The Guide to Diversification." Accessed May 24, 2020.
- Fidelity. "Duration: Understanding the Relationship Between Bond Prices and Interest Rates." Accessed May 24, 2020.
- Bureau of Labor Statistics. "Food at Home Prices Up, Gasoline and Airfare Prices Down, Over the Year Ended April 2020." Accessed May 24, 2020.
- Fidelity. "Tax Implications of Bonds and Bond Funds." Accessed May 24, 2020.
- Internal Revenue Service. "2019 Publication 550: Investment Income and Expenses (Including Capital Gains and Losses)," Page 19. Accessed May 24, 2020.
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.