Advantages & Disadvantages of Financing Corporate Bonds or Stocks
Original post by Geri Terzo of Demand Media
There are both advantages and disadvantages to issuing corporate bonds or stocks for financing. Market and economic conditions may dictate which type of financing is most appropriate at a given point in time, but there are certain features that are common with both types of activity. Issuing either bonds or stocks gives an issuer greater access to capital, but the transactions have an affect on a company's balance sheet and shareholders.
Financing with corporate bonds is an especially attractive option when borrowing costs, or interest rates, are low and money is considered cheap. According to an article on the Wall St. Cheat Sheet website, after interest rates dropped to the lowest levels of the year in May 2010, the bond markets attracted first-time entrants, including Google, which issued its first bonds. The rate environment inspired Johnson & Johnson to launch its largest ever bond issuance. Since debt needs to be repaid or a company risks default, debt issuance causes companies to budget cash flow.
A disadvantage to bond financing is that by issuing bonds, a corporation becomes indebted to shareholders. The amount of debt that is borrowed in a transaction is added to the issuing entity's balance sheet, which could affect future borrowing costs. An issuing company also becomes beholden to debt lenders, and must regularly make interest payments for the duration of the bond contract. If payments are missed, the company defaults and becomes vulnerable to bankruptcy.
By selling stocks in an initial public offering or a follow-on offering, companies receive cash injections that can help finance operations. A company can expand faster, hire addition personnel and take on new projects. The capital raised in an equity financing could be used to finance a merger or acquisition. Equity on a balance sheet is also likely to improve a company's debt-to-equity ratio, which can create better financing terms in the future.
Upon issuing stock into the market, a company's executives are relinquishing some control of the business. Equity shareholders become part owners in the public entity and obtain the right to vote on important company developments. Issuing additional equity into the markets also dilutes the percentage ownership that public shareholders have, according to the Inc.com, and could cause existing stock owners to sell shares and drive the value of the stock price lower.
- Mount Holyoke College: Why Do Corporations Issue Bonds?
- New York University Stern; The Debt-Equity Trade Off; Aswath Damodaran
- Wall St. Cheat Sheet; Watch Companies Rushing for Cheap Money Before the Spigot Closes; Evan Hawk; May 2011
- "Inc."; A Primer On Equity Dilution; Michael Lechter; January 2008
About the Author
Geri Terzo is a business writer with over 15 years experience reporting on Wall Street. Her coverage ranges from institutional investing, including hedge funds and investment banking, to family topics and her career experience includes work for Fox Business, CNBC and "IDD Magazine." Terzo is a graduate of Campbell University, where she earned a B.A. in mass communication.