Why do corporations issue bonds?
Companies fund themselves with a mixture of bank finance, bonds and equity. Banks will lend to companies of all sizes, from the corner shop to the largest corporations in the world. In contrast, as we have seen, the bond market would normally only be a consideration for those who wish to borrow more than GBP 100m.
The appeal of the bond market for these companies is likely to be:
- the conditions attached to borrowing in the bond market are less strict than those demanded by banks. For example, a bank will typically demand that their loan be secured against the assets of the company, whereas this is a less common requirement in the bond market.
- the bond market will lend to companies for a longer period than is typical in the banking market. This is attractive to companies with significant or long-lived assets, such as utility and property companies; and
- large companies that choose to borrow large sums of money will want to ensure that they have a wide range of fund providers, lenders, to ensure that their borrowing programme is not excessively dependent on a small number of banks. The bond market allows these companies to seek funds from a broad range of investors.
Equity has two features that make it an attractive means of financing a company:
- it is permanent capital and once issued there is no obligation to repay it unlike both bank and bond finance must be repaid on the agreed date; and
- it is loss absorbing and the equity holders bear the risk of the value of the equity degrading as result of company performance, whereas banks and bondholders require companies to maintain a minimum level of capital , and may demand immediate repayment if a company fails to do so.
The permanent nature of equity financing and its capacity to absorb losses make it attractive to companies, but it is also the reason why equity investors expect higher returns than bondholders. The boards of companies must decide on the mix of finance that they judge is right and which satisfies the different requirements of their capital providers.
In summary, the particular mix of bank, bond and equity financing chosen by a company will be influenced not only by the size of their capital needs and the business activities undertaken, but also by the policies of the company’s board and the relative cost and availability of the rival financing alternatives. There is not one right way to finance a company and the best available way will change as the business evolves and the attitudes of banks and investors change.