One thing that you may not know about corporate bonds right off the bat: Issuing a corporate bond might be a necessary step in growing your business. When companies reach a point where more funding is needed, this is one key option to consider. Follow this checklist to explore the major factors to weigh in deciding whether a corporate bond is your best financing option.
- Does the company need to raise the funds externally?
Funding from external sources is always more expensive than using internal sources, so seeking the required funds internally is an important starting point. Places to look include subsidiaries with surplus cash, or perhaps a review of cash management across the group is necessary. A review can usually identify areas for improvement such as debtor, stock, trade or creditor management, capital expenditure, recruitment, executive perks, asset disposals, and bank cash management such as float time, bank charges and idle surplus cash.
- If cash must be raised externally, how much is needed now and in the future?
A cash flow forecast that is updated periodically, setting out receipts, payments and net flows per month, can provide a useful guide to funding needs, thereby avoiding unnecessary interest costs from borrowing too much cash too soon. (Several factors affect the taxable interest that must be reported. Learn more in Bond Taxation Rules.)
- Which market would be optimal for the issue?
Should the offer be a private placement or public? Should the banking market be used instead of the capital markets, either exclusively, or in combination, and if so should it be a bilateral or syndicated bank transaction? Get the advice and view of the company's relationship banks, and weigh the benefits and drawbacks of each market carefully. (Corporate eurobonds simplify expansion for MNCs, though there are a few more hoops to jump through. Check out The Ins And Outs Of Corporate Eurobonds.)
- Should the bond be secured, fixed rate, convertible to equity or have early redemption options?
This is an important aspect of the issue to consider, as it will affect when and how much financing the company stands to receive, as well as the company's risk in issuing the bond. (Find out how businesses weigh the pros and cons of convertible bonds as an alternative form of financing, see Why Companies Issue Convertible Bonds.)
- Is a debt issue the most appropriate way to raise the required funds?
Issuing more debt might raise the company's gearing too high, so perhaps an equity issue is better. A company might also consider a issue quasi-equity such as mezzanine debt or a hybrid bond. Seek out the views of the company's rating agencies and determine whether they would view the issue favorably in terms of the company's credit rating.
- Is debt appropriate given the company's stage of development and its ability to service the debt obligations or the economic outlook for the company over the expected life of the debt?
If the company is a start-up, it is unlikely to generate revenue for a few years, until it has a product or a production facility, so an added burden to pay interest might soon drive it into insolvency. If the company is experiencing a lull in revenue because of a recession, debt will only exacerbate its cash flow problems, so it's better to defer debt interest if possible, such as by issuing a zero-coupon bond. (Learn more in our Advanced Bond Concepts Tutorial.)
- What non-negotiable terms will the company need to accept from lenders?
These include terms related to the interest rate, security, term of the debt, covenants, early repayment, currency and convertibility. Consider how much each of these will constrain the company's operations over the term of the bond, and whether the company will be forced to pay excessive fees for waivers.
- Is there a well-functioning market for the company's debt?
If the company's debt is illiquid, it is likely to be relatively expensive owing to illiquidity. The market the company chooses to issue in could set a precedent for subsequent issues in that market as well. (You might want to check out Bonds You May Never Have Heard Of.)
- Will the company need to execute hedges to manage risks?
Currency and/or interest rate risks might apply. If the company intends to hedge such risks, how will these hedges be executed and administered? Does the company have the necessary expertise and infrastructure to execute and administer hedges? What are the tax and accounting implications of these hedges on the company's P&L and balance sheet? Will they for example, meet hedge accounting? Will withholding tax be deductible, thereby reducing investors' yield? (For more insight, see Corporate Uses Of Derivatives For Hedging.)
- Has consent been obtained if waivers from other debt providers will be necessary to issue the debt?
If for example, the bond is to be secured but the company has already given a negative pledge to existing debt providers, a waiver could be required.
- Who is going to arrange the transaction and administer it?
Who is the issuer going to be and where will it be domiciled? This decision can have significant implications for subsequent tax treatment. (Learn more in Who are the major players in the bond market?)
- What will the various transaction costs be (in addition to interest rate)?
Transaction costs include underwriting and arrangement fees, hedging, rating agency fees, printing, listing, trustee fees and custodian fees. Find out which costs apply to your company how much these costs will be. How does this cost compare to the company's other sources of funding?
- What is the urgency of funds and can this be met with this debt issue?
Ongoing needs for funds can often be met efficiently with a program of issuance, such as a medium-term note program, or a commercial paper program, whereas single large term issues can take longer to prepare and execute. Private placement transactions are relatively quick to arrange since, in contrast to public issues, they avoid the regulatory requirements of producing listing documentation and seeking listing exchange approval.
There are many factors to consider when your company requires a new source of funding. Be aware of all your options and, most importantly, the implications that go along with each choice. There is an option that is right for your company. (Learn how and why investors are using cash flow based analysis to make judgments about company performance, read Taking Stock Of Discounted Cash Flow.)