Taking out a bank loan and issuing debt are both methods businesses use to borrow money, but there are important differences between the two. Loans tend to be more expensive and bankers may impose restrictions on how the funds can be used. When a business issues debt, it sells bonds to investors. Each bond is a promissory note that spells out the terms and conditions for payment of interest and redemption when the debt matures. The firm can use the money as it sees fit, since it writes the terms when issuing debt.
How Debt Is Issued
Before a company can issue debt, management must review the firm’s financial position. The business has to be free of restrictions on issuing debt as the result of existing collateral agreements with lender banks. Issuing debt increases risk. Should the company fail, bondholders are paid off before shareholders get anything. Consequently, the firm must have sufficient cash flow to make bond interest payments. Assuming the company is in a position to issue debt, management drafts a proposal and presents it to investment bankers and underwriters that help to market the bonds. A syndicate then is formed to market the bonds to investors.