There are times when all companies need to raise money – whether it’s to fund an acquisition, to research and develop a new product, or enter a new market – few companies can do this without raising capital to fund their endeavours. Issuing bonds is one of the ways companies can raise capital.
A corporate bond can be viewed as a loan from an investor to a company. A bond is basically an IOU, with the returns to investors determined by two factors as illustrated in figure one:
- The face value of the bond (e.g. $100), which is repaid when the bond matures
- The coupon, or interest payments made over the life of the bond.
Figure one: How a bond works
Source: Australian Corporate Bond Company
In short, if you were to invest in a corporate bond, you are making a loan to that company; you, the investor, gives the company a specified sum of money for a specific period of time. In exchange, you receive regular coupons, or interest payments at designated times. When the bond reaches maturity, your loan is repaid
Bonds and loans both fall into the category of debt finance; the company borrows a sum of money, commits to repay it at the end of a specified term, and makes interest payments along the way.
Although the terms of a bank loan will vary according to each company, many come with strings attached; banks often require companies to comply with a variety of terms to qualify for the loan. Restrictions are generally for the duration of the loan, and might include:
- the way the borrowed capital is used in the business
- prevention from making acquisitions
- other capital raisings, through debt or equity issuance
Such restrictions can impact a company’s operations and may prevent it from taking advantage of opportunities that arise during the term of the loan. Many bank loans are of a shorter duration; while longer-term loans can be negotiated, most have an upper limit of five years.
Table one: Corporate bonds versus bank loans
|Flexibility to use capital as company sees fit||YES|
|Fixed and variable interest rates||YES||YES|
|Short to medium term finance||YES||YES|
|Longer term finance||YES|
|Interest payments are tax deductible||YES||YES|
|Provides investment opportunities||YES|
Shares fall into the category of equity finance; this includes ordinary shares, preference shares, rights issues and other forms of capital raising in the equity market.
Shares represent a proportional ownership stake in a company in exchange for capital. Unlike debt finance, the capital raised from the sale of equity does not need to be repaid.
On the downside, raising capital through equity puts ownership of the business into the hands of shareholders, who expect a share of the profits in return for that capital. While shareholders generally don’t place restrictions on the day to day running of a large corporation, the rise in shareholder activism has seen a greater number of companies’ decision making influenced by investors.
If a company requires additional capital and issues further equity, it can dilute the shares on offer. This, in turn, can negatively impact the share price and have an impact on important metrics such as earnings per share, which many investors use as a yardstick when comparing different equity investments.
With corporate bonds on the other hand, companies can issue new bonds without affecting corporate ownership or voting rights of the company.
Table two: Corporate bonds versus equities
|Flexibility to use capital as company sees fit||YES||YES|
|Investors have ownership stake in company||
|Issuance can impact company share price||
|Longer term finance||YES||YES|
|Provides investment opportunities||YES||YES|
The corporate bond market provides Australian businesses with a broader range of potential sources of finance. It also provides great opportunities for investors to access an asset class that offers both security and predictable returns.
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- Bond Measures Explained
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- Your Guide to the World of Corporate Bonds [INFOGRAPHIC]