A bond is a debt investment in which the investor lends money to the government or an institution in exchange for an issuance of bonds. The issuer is the entity that uses the money for several purposes, such as, additional capital, investments and acquisition. This practice presents both advantages and disadvantages but remains to be a popular choice among investors. Just as bonds have pros and cons to investors, the issuer of bonds will also experience advantages and disadvantages. Here are some of the benefits and drawbacks of bond issuance.
List of Pros of Issuing Bonds
1. Source of Cash
For companies in need of extra capital or resources for business operations, issuing bonds is one of the most effective techniques to do it. By issuing bonds, you get money from investors without making them part owner of the company. You only need to pay interest for letting them use their money and even if they have invested money in your organization, they are still not part of decision-making.
2. Tax Deductible
Another advantage of bond issuance is related to the interest an issuer has to pay its investors. This is because the payment of interest is subjected to tax deductions and considered an expense to the company. While this makes it possible to have money for business operations, it also reduces the taxes that need to be paid.
3. Access to Funds
People who prefer issuing bonds over selling stocks say that this lets the company to borrow money only when at a time it is needed. Instead of borrowing from banking institutions, companies can borrow from investors and only pay lower interest rates. Moreover, the issuing company can decide the period of maturity of the bond from 3 years or 30 years, depending on their preference. This also gives them control of their debts.
List of Cons of Issuing Bonds
One of the setbacks of issuing bonds is the limited power or control of the issuer over where the money borrowed will be used. Since the investor wants to ensure that the money will be used responsibly, there will be limitations placed on the disbursement of the bond, say in the case of a governmental agency that issues the bond. If the money was intended to the construction of a bridge, this is where it should go. The bond cannot be allocated for use of another project.
The money invested in bonds need to be repaid on a monthly basis until it matures, in which the issuer need to pay back the principal amount borrowed. As opposed to stocks where the company will not be responsible in case the stocks did not perform well, issuing bonds means that the issuer will have to come up with the interest payment regularly.
Another disadvantage of bond issuance is the obligation of the issuer to pay the investor the interest regardless of the financial status of the company. In stocks, the company is not liable to the investors if the stocks are down unlike in bonds where the issuer has to pay the investor. In addition, the interest rates will be a deduction to the profit of the company.
Issuance of bonds has both advantages and disadvantages. Any entity planning to sell bonds should understand the opportunities and responsibilities of these transactions.
Natalie Regoli, Esq. is the author of this post and the editor-in-chief of our blog. She received her B.A. in Economics from the University of Washington and her Masters in Law from The University of Texas School of Law. In addition to being a seasoned writer, Natalie has almost two decades of experience as a lawyer and banker. If you would like to reach out to contact Natalie, then go here to send her a message.