Why do Companies Issue Bonds?

By Advisorymandi Forbidden
24-April-2019 4:14:25 PM
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You must’ve have seen many corporate companies and organizations issuing stocks for raising funds. It is the best way to raise money for the organization. But, it is not the only way to do it! There are other ways to raise funds for the company but not all as effective as issuing stocks except bonds. Sometimes when a company is in need of funds, issuing bonds is one way to do it.

In issuing a bond, the bond works as a loan between investor and company. An investor agrees to give the company a specific amount of money for a specific period of time in return for periodic interest payments at regular intervals.

When the loan reaches the maturity period, the investor’s loan amount is repaid to the investor.

But, the question still stands, why do companies issue bonds?

What’s the reason behind corporations issuing bonds instead of stocks?

Well, there are several factors that drive the decision of issuing bonds instead of other methods for raising funds. To get clear insights, we’re going to compare the features and benefits of bonds with other common methods of raising money and why do companies need to bonds issuance when they are in need of raise cash to fund corporate activities.

Shouldn’t Companies Approach Bank?

Well, you are right to think that way. If a company is in need of raising money then it can simply approach the bank to take the loan.

Why would a company issue a bond instead of borrowing from the bank?

A company can take a loan from the bank just like a normal person but issuing bonds would be a more attractive approach to do this. Besides, the interest rate at which a company pays to obtain a bank loan would be higher than the interest rate company pays bond investors is often less.

The company can use its profits to pay out investors. This is why many companies consider issue bonds when the interest rates are low. Not only has it given the advantage to companies to take loans on extremely low levels but also the ability to grow.

Another benefit of issue bonds is the level of freedom. When a company goes for using bonds, it releases it from the restrictions attached to bank loans. For instance, there are a lot of restrictions for a lender when on bank loan such as the lender often required companies to agree to certain conditions. One like, when the lender cannot issuing more debt and not making organization acquisition until the loan amount is not paid in full.

Thus, many companies choose debt over interest rates. On a personal level, it may not cause much of problem but as a company, it can hamper its workflow.

If that’s the Case Why Shouldn’t Companies go for Stock Issuance?

Now that you’ve got some idea of issuing bonds – can you tell why some companies issue bonds, not stocks?

Well, as you know that when a company issue stock, it grants proportional ownership in the company for investors in exchange of money. The benefit company gets from issuing stocks is they do not need to be repaid. But, it comes at the cost of ownership. In stock issuance, the future earnings must be shared with all the investors of the company. Sometimes, it can result in a decrease in earnings per share (EPS), which put less money in the owner’s pocket.

When an investor sees decrement in EPS, the value of the company in investors’ eyes become less valuable and not seen as a favorable development. Issuing more shares also means you will be giving away your ownership to a large no. of investors which often makes share value worthless.

But, with bonds issuance, companies can raise money for funding operations and business activities without granting ownership of the company to the investors. Furthermore, the company can issue more bonds in the future to raise funds.

Final Thoughts: –

Overall, we can say that bond issuance is one efficient way to raise money for the company. In fact, it attracts a large no. of lenders in an efficient manner. Not only the company can keep ownership intact, but it can also get more lenders with time to raise the money without worrying over the EPS and ownership.

 

Hope, this article helped you in a way you expected it to be. If you have any query or would like to add something then doesn’t forget to mention in the comment section below.

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Author: Advisorymandi

AdvisoryMandi is India's most trusted Stock Market Advisory marketplace covers NSE, BSE, MCX & NCDEX. Invest with confidence and harness the power of AdvisoryMandi to make smarter investment decisions in Stocks, Indices, Commodities, Forex & IPO.

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