The Disadvantages of Issuing Bonds

Issuing a bond may raise needed capital, but it comes at a cost that goes beyond the interest payments. The issuer takes on several constraints in terms of its investment activities, the use of money raised by the issue, and liabilities toward bond investors. While issuing a bond may be the right decision to fulfill a business objective, bond issuers should understand their responsibilities throughout the process.

The issuer of a bond seeks to borrow money by issuing debt. A bond is a debt obligation in that an issuer receives money from an investor for a specified period of time before the issuer returns the money to the original investor on the maturity date In addition to paying the sum of money back to the original investor, the issuer generally will pay an additional amount to the investor as compensation for the privilege of borrowing the money -- called interest. Other bonds don't present investors with interest, but sell at a discount to the face value instead. The issuer can be an individual, corporation, or a public entity, all of which are looking to raise money from investors.

Unlike bond investors, stock investors are not expected to receive repayment of their investment because they are obtaining ownership through the shares purchased. If a stock issuer's operation or company fails, those who own shares will see their investments suffer accordingly. Bond investors, on the other hand, expect repayment of their investment, regardless of the issuer's bottom line.

In an effort to ensure that an issuer does not do anything reckless with the invested money from a bond issue, investors often will place restrictions on the issuer. Money generated from the bond usually is earmarked for a specific purpose. This places constraints on an issuer’s business activities, and potentially leads to negative consequences if it commits the issuer to a strategy that is later proven to be suboptimal. A municipal government that issues a bond for a new highway, for example, can't reallocate the funds for mass transit even if it later determines the latter approach would better serve area residents.

Stock investors usually have no legal recourse in the event their investment is lost; this is not that case with bond issues. Bond issuers are liable for repayment of debt to lenders in the unfortunate event that a business goes under.