When companies want to raise their money to finance their operations, they issue debt. Companies can raise there funds either by borrowing money from banks or by issuing shares or bonds. Sometimes instead of borrowing money from banks or selling shares, they issue bonds. When an organization offers bonds for sale to investors, this is often referred to colloquially as “issuing debt.” This bond is a coupon that contains the specific information about how much money the company borrowed and how much money the company has to repay by a specific interest rate in a certain amount of time. It is basically a contractual obligation on the part of the issuer to pay back the debt owed to the bond’s holder.
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Why Issuing Debt Is Better Than Taking Loan From Bank?
Companies can also raise there funds by taking loans from banks as selling bonds is an another way of borrowing where company borrows from investors and pay interest on the borrowed money. Companies can ask banks for loan, but it is a difficult and much expensive option. One major reason that makes issuing debts better than asking for loan is that bond holders are much more forgiving than banks.
Why Issuing Debt Is Better Than Selling Shares?
Companies can also raise there funds by selling shares. By doing so, they will lose the ownership of some parts in the business. Even the government uses the same method in raising money to finance their projects. Governments issue debt in other countries or international institutions like World Bank, and International Monetary Fund.
Companies face the challenge of determining whether to issue debt or not for financing needs. Issuance of debt have advantages and disadvantages.
Advantages of Issuing Debt
- Issuance of debt has a tax benefit because of the debt tax shield. The interest payments to debt owners are expensed, it will cause reduction to tax income. A company with a higher tax rate thus has a higher tax benefit from debt issuance.
- Future debt obligations can be easily forecasted and planned for. This is because debts add discipline to the management. Interest expenses yields lower cash flow leftovers. This makes the management more likely to be reliable, efficient, and non-complacent.
Disadvantages of Issuing Debt
- Debt issuance increases bankruptcy risk because debt owners can take control of the company if interest payments are not made.
- Debt owners have different wants than stockholders. Issuing debt may increase this separation between debt and stockholders.
- Future financial flexibility may be reduced by issuance of debt. Lenders must make consistent interest payments on issued debt, this will reduce financial flexibility. In addition, issuance of debt may reduce the amount or increase the cost of future debt financing.
Some of many instances companies management takes market condition into consideration while deciding whether to issue debts or equity. One of the major reason that can lead companies to issue debts are when equity markets are depressed. Companies will prefer to issue debt to raise their monetary pool , rather than to sell their shares. During market depressions, share prices can become substantially low. Thus, it will only give the share holder less of the money needed for their financial operations. To issue debts means liability to companies.