The Advantages & Disadvantages of Bonds Over Stock With Long-Term Financing
Original post by Leslie McClintock of Demand Media
If you are looking to raise capital to run or expand your business, there are two primary ways of doing it. You can sell an ownership interest in your company to a partner or to the general public in the form of stock, or you can seek out a loan in the form of a bond. Each has advantages and disadvantages, and there is no one correct answer that is right for every corporation.
Selling stock allows you to raise capital without the risk of bankruptcy. You can only go bankrupt on money you borrow from someone else, or as a result of a judgment against you. When you sell stock, you also may be able to take advantage of the buyer's expertise, contacts, labor or services.
When you sell stock, you effectively dilute your ownership interest. You have to share your profits with one or more other shareholders. If you don't keep ownership of 50 percent of the company, you also lose control of the corporation. Other shareholders can make decisions for the company that you may disagree with. Finally, when you sell stock in your company, you must consider what your interests are if another stockholder should die or become disabled. You may want to buy out the interests, since the heir of a deceased owner may not bring the same expertise or devotion to the company as the deceased did. This may call for a business succession plan, buy-sell agreement, and life insurance funding. Finally, if you sell stock for more than your basis in the shares, there could be a capital gains tax consequence for you.
Advantages of Bonds
The main advantage of issuing bonds is that you do not have to share profits. Your costs are fixed, and as long as you can cover the debt servicing, you get to keep the rest. Additionally, once the bond is paid off, you have no further obligation to the bondholder. Your payments are temporary. Also, no matter how much you borrow, you will still maintain executive control of your company. There is no tax consequence to borrowing money, unless the loan is eventually forgiven.
Disadvantages of Bonds
With bonds, you will have a fixed liability payment to make with little or no flexibility. If you default on a bond payment, creditors could force you into bankruptcy, and possible into liquidating your business. Additionally, while the interest rate on ownership capital in the long run is zero percent, there is an interest rate on bonds.
About the Author
Leslie McClintock has been writing professionally since 2001. She has been published in "Wealth and Retirement Planner," "Senior Market Advisor," "The Annuity Selling Guide," and many other outlets. A licensed life and health insurance agent, McClintock holds a B.A. from the University of Southern California.