Why Do Corporations Issue Bonds?
Corporations issue bonds to raise capital for their business for investments over the short-term or the long-term. There are a number of reasons why corporations may choose to issue bonds to raise funds, including the possibility of onerous loan terms and a lack of long-term financing from banks, as well as the relative ease of raising funds through the bond market among others.
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Efficiency
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Issuing bonds is an effective and efficient way to raise capital. Say a corporation has to raise $10 million dollars rapidly, and seeks bank financing. One bank agrees to loan the corporation just $5 million dollars over six years at a 10 percent interest rate; another will only lend the corporation $1 million dollars over three years at 12 percent interest, and a third will lend the corporation the balance over four years at a 15 percent rate.
Beyond the time it takes to obtain bank financing, especially given the possibility of having to deal with multiple lenders, the corporation now has to deal with three separate contracts, which have different repayment stipulations. By contrast, a bond offering gives every creditor the same terms and the same rate. A single loan contract, called a bond indenture, is made available to prospective buyers, and every bond buyer agrees to those terms, radically simplifying the process.
Long-Term Financing
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Bonds are ideal for long-term financing, from which banks may shy away from because long-term financing presents certain risks to banks. Among these risks is the possibility that interest rates will rise. If the bank enters into a fixed-rate contract with a corporation and interest rates rise, the bank will have lost the ability to earn higher returns on the loaned funds. There is also the possibility of a long-term decline in the debtor corporation's credit-worthiness.
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Lower Interest Payments
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Bond issuing corporations can offer bonds at a lower interest rate than they might be charged at a bank. Investors buy bonds not just for interest income, but for speculative reasons. A bond with low interest rates may sell inexpensively on the open market and be advantageous for the corporation, and potentially, an investor.
No Dilution of Stockholder's Equity
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Raising funds through stock dilutes shareholder's equity -- or reduces the amount of the ownership of current shareholders. This is not a popular option as investors may respond by selling their shares and driving stock shares down. Bond financing allows a corporation to avoid diluting shareholder equity.
Hostile Takeover Financing
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Junk bonds are often used to finance hostile takeovers, because they provide a substantial amount of cash to the corporation seeking to make the acquisition. The high yields may assuage the fears of investors concerned that the issuing corporation may not be able to repay the loan in full if the takeover attempt fails.
Daily Operations
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Short-term bonds, maturing in nine months or less, are known as commercial paper and are used to finance ongoing business operations. These too generally afford the issuing corporation the ability to make lower interest payments than they would on a bank-issued line of credit.
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