Why Would a Company Issue Bonds Instead of Stocks?

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A company trying to decide whether to issue bonds, which are debt, or stocks, which are equity, may have a difficult choice to make, because both asset classes produce benefits. However, a company with sufficient cash flow and the discipline to maintain consistent principal payments to its lenders might choose bonds.

Differences

  • When a company issues bonds, it is borrowing money from future bondholders or lenders. The principal must be repaid with interest. Equity issuance involves selling additional stock in the stock market, which dilutes the percentage of shares owned by existing stockholders. Bond issuance does not dilute shares because, unlike stockholders, lenders do not have any equity ownership in a company.

Raising Capital

  • A company issues either bonds or stocks to raise capital, usually for expansion. A pharmaceutical company might raise capital to fund the costly process of developing and testing a new drug, while an oil and gas company might use the proceeds to finance drilling activity in a promising new field.

Tax Benefit

  • Companies may choose to issue bonds over stocks for the tax benefits. Bond issuers must make consistent interest payments to bondholders, but these payments are tax-deductible.

Risks

  • When a company issues debt or sells bonds in the market, it becomes more vulnerable in the event of a bankruptcy filing. Bondholders gain priority in a bankruptcy filing and can win control of a company if the debtor misses interest payments on the loans.

Financial Analysis

  • Debt analysts report on whether a company with debt has sufficient capital to repay its bondholders and analyze signs of weakness in a company. Equity analysts look for business strength, focusing on a company's growth potential and any prospects that might expand profitability. Both provide value to investors.

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