Corporate bonds are used by many companies to raise funding for large-scale projects - such as business expansion, takeovers, new premises or product development. They can be used to replace bank finance, or to provide long-term working capital.
The main features of a corporate bond are:
- the nominal value - the price at which the bonds are first sold on the market
- the interest rate paid to the bond owner - this is usually fixed
- the redemption date - when the nominal value of the bond must be repaid to the bond holder
Bonds can be sold on the open market to investment institutions or individual investors, or they can be placed privately. For more information, see advantages and disadvantages of raising finance through private placements.
If bonds are sold on the public market, they can be traded - similar to shares. Some corporate bonds are structured to be convertible, which means they can be exchanged for shares at some point in the future.
Advantages of issuing corporate bonds
Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. They can also offer a way of stabilising your company's finances by having substantial debts on a fixed-rate interest. This offers some protection against variable interest rates or economic changes.
Other advantages of using bonds to raise long-term finance include:
- not diluting the value of existing shareholdings - unlike issuing additional shares
- enabling more cash to be retained in the business - because the redemption date for bonds can be several years after the issue date
Disadvantage of issuing corporate bonds
There are also some disadvantages to issuing bonds, including:
- regular interest payments to bondholders - though interest may be fixed, the interest will usually have to be paid even if you make a loss
- the potential for your business' share value to be reduced if your profits decline - this is because bond interest payments take precedence over dividends
- bondholder restrictions - because investors are locking up their money for a potentially long period of time, they can impose certain covenants or undertakings on your business operations and financial performance to limit their risk
- ongoing contact with investors can be somewhat limited so changes to terms and conditions or waivers can be more difficult to obtain compared to dealing with bank lenders, who tend to maintain a closer relationship
- having to comply with various listing rules in order to increase the tradability of the bonds listed on an exchange - particularly, an obligation to make information on the company publicly available at the issue stage and regularly during the life of the bond
Additionally, although it isn't a mandatory requirement, having a credit rating can help you launch a successful bond issue. However, this is time consuming and will be an added cost to issuing the bonds.