What Are the Advantages & Disadvantages of Issuing Debt?
As companies grow, they need to acquire addition funding to finance that growth. Many companies choose to issue bonds as a way of acquiring the necessary funds. Bonds represent a loan from each bondholder to the company. Companies need to consider the advantages and disadvantages of issuing bonds in order to make an educated decision.
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Retain Ownership
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One advantage companies experience by issuing debt is the ability to retain the current ownership status. Some companies choose to sell a portion of the business either through the sale of stock or by bringing in an additional partner rather than issuing debt. This option reduces the current owners' share of the business, reduces their portion of the company's income and reduces their decision-making ability.
Achieve Funding
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Another advantage of issuing debt is that funding is easily accessible. Investors choose to purchase bonds because of the right to receive regular interest payments and the return of their investment at the end of the bond term. Investors feel assured that they will receive their money as scheduled. Investors who purchase stock receive no assurance of receiving a return on their investment and risk losing it if the company performs poorly.
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Repayment
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A disadvantage to issuing stock involves the cash outflows required by the company. The company must make regularly schedule interest payments to the bondholders and pay each bondholder the face value of the bond when the end of the bond term is reached. The interest payments are expenses for the company and reduce the company's net income each period. The repayment of the bond's face value requires a large cash outflow at the time of payment.
Debt To Equity Ratio
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Another disadvantage is the impact that issuing debt makes on the company's debt to equity ratio. Increasing the company's debt increases the company's debt to equity ratio. The company's debt to equity ratio communicates what portion of the company's assets is funded by debt instruments and what portion is funded by equity investments. The higher the ratio the higher the portion funded through debt. As a company's debt to equity ratio increases, investors wonder about the company's ability to meet those debt payments.
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