Advantages & Disadvantages of Funding Money From Bond Issuance
Original post by Michael Wolfe of Demand Media
Both companies and governments often choose to raise capital by issuing bonds. Bonds are essentially loans, although instead of being taken out from a single lender they are issued onto the investment market, and investors are allowed to buy and sell these debt obligations publicly. While funding an organization by issuing bonds has a number of advantages, it also has a number of very steep downsides.
Quick Source of Funds
The chief reason a company will issue a bond is that it is a relatively quick way of raising a very large amount of money. When a bond is issued -- assuming it is priced that so it will be sold out -- the company can expect to receive payments in the amount of the bond issuance. This money can be used to support capital investments and raise more money, to pay the bond back and to grow the organization.
Another advantage of bond issuances is that they allow a company to restructure its debt. For example, a company may have debts that are due in the short term. To pay these debts off, the company can float a long-term bond, thereby giving it financial breathing room. This is a bit like restructuring credit card debt into a long-term mortgage -- often with the same lower interest rate.
Investors will not just purchase a bond out of goodwill: They expect to receive compensation for the risk of financing someone's loan, in the form of interest. If the debt is large or if the company does not have a good credit rating, then the borrower can expect to spend large amounts of money servicing the debt. Other forms of financing, such as issuing stocks or taking on new investors does not carry the same kind of risk.
Risk of Default
Many bonds are floated with the assumption that the money culled from the issuance will be used to create new cash flows that can be used to pay the bond's buyers back in the future. If these cash flows are not created, then the organization stands a risk of defaulting. This will badly hurt the organization's credit rating, making it harder to take out loans in the future and perhaps jeopardizing other investments.
- "Economics"; Roger A. Arnold; 2009
About the Author
Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.