What’s a Corporate Bond?
Are you considering different debt financing methods for your business? Read this article to learn about what a corporate bond is.
There are two main ways a company can raise money. These are debt and equity financing. Debt financing involves the company incurring debt in exchange for money. Alternatively, equity financing involves selling an amount of ownership in the company in exchange for money. Issuing a corporate bond is a form of debt financing. Read this article to learn more about what a corporate bond is and whether it could be a solution for your business.
What is a Corporate Bond ?
Put simply, a corporate bond is a small loan between a company and an investor. This means that a company will sell a bond to an investor. In exchange, they will promise to repay the bond amount plus interest. Generally, the interest amount and repayment schedule are fixed when the bond is purchased.
Company A needs to raise money to quickly get a new product to market. Company A issues a corporate bond to an investor. It sells the bond for $10,000 and in exchange promises to pay the investor a $250 ‘coupon payment’ each year for 5 years. Additionally, at the end of the 5 years, the company will also repay the original $10,000 to the investor. Company A repeats this process with nine other investors to raise $100,000 in total.
What are the Pros and Cons of Issuing Corporate Bonds?
There are some significant advantages to issuing corporate bonds over other kinds of financing:
- It doesn’t require you to sell assets;
- It is cheaper than issuing shares because it doesn’t reduce the value of existing shares; and
- Interest payments to bond owners are an expense and therefore tax-deductible.
There are also some disadvantages to issuing corporate bonds:
- It creates a fixed obligation to pay back investors; and
- It’s riskier than equity financing.
What are the Pros and Cons of Purchasing Corporate Bonds?
The advantages of purchasing corporate bonds are:
- Greater certainty around coupon payments;
- Bondholders rank higher than other creditors if a company were to experience solvency issues; and
- Generally, corporate bonds have a better return rate than other bonds;
The disadvantages of purchasing corporate bonds are:
- Corporate bonds are riskier than government bonds;
- Generally, there is no opportunity for your investment to experience capital growth;
- Selling corporate bonds isn’t as simple as selling other assets; and
- If interest rates rise then bonds are less profitable.
In summary, corporate bonds are a form of debt financing. In essence, they are where an investor loans a company money in exchange for repayment of the loan plus interest. Generally, they are a lower risk investment because of the fixed nature of their terms. On the other hand, for companies, they are a method of financing which can be helpful depending on the circumstances. Above all, if you need help with issuing corporate bonds it’s best to seek professional legal advice.
Alex is a Legal Tech Intern at Lawpath as part of the Content Team. He is in his fourth year of a Bachelor of Laws with the degree of Commerce (Majors in Entrepreneurship and Accounting) at Macquarie University. He is interested in Corporate and Commercial law.