What is Issuing Debt?
When companies want to raise their money to their finance operations, they issue debt. Instead of borrowing money from banks or selling shares, they issue bonds. 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.
What is the difference between loaning from banks and issuing debts?
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 bondholders are much more forgiving than banks. Companies can also sell 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.
Some of many instances that can lead companies to issue debts are when equity markets are depressed. Companies will prefer to issue debt to raise their monetary pool for financing operations, 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.
What are advantages of Issuing Debt?
- When issuing debt, it is subject to debt tax shield. This means interest payments to owners are expensed, it will cause reduction to tax income. Companies with higher tax rate have higher tax benefit from issuing debt.
- 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.
What are disadvantages of Issuing Debt?
- Debt issuance has high bankruptcy risk. Debt owners reserve the rights to take control of the company if the interest payments are not complied.
- Debt owners have different wants and desires than stockholders. To issue debts means greater chance of separation between debt and stockholders.
- Future financial flexibility may be reduced by issuing debts. Lenders must make consistent interest payments on issued debt. This will reduce financial flexibility. Issuing debts may reduce the amount or increase the cost of future debt financing.
Debt Securities help maintain the concentration of ownership in an organization and provide an alternative way of raising money.
To issue debt securities, a company must follow certain rules:
- A company must evaluate collaterals. It must be free of charge and it can be securitized.
- Details of an in-house proposal must be present including cash requirements for the company.
- Deliver a debt-issuance proposal to the perspective investment bankers.
- Select the suitable banker that is prepared to the best execution services and also for a reasonable cost.
- Legal documents regarding debt issuance must be prepared at all times.
- Form an underwriting syndicate that is prepared to invest in the debt issue.
- Market the debt securities through the help of the investment bank.