Corporate bonds are a financial tool that a corporation uses to raise funding. They are an alternative to acquiring loans from a bank or issuing shares of stock. Corporations use the money from bond sales to finance a variety of improvements, like business growth, new factories, or new equipment. When an investor buys a corporate bond, he is essentially buying an IOU from the corporation that is to be paid back after a pre-determined time (the maturity date). The bond will also typically pay coupon payments, which are interest-based payments made to the bondholder at regular intervals (usually semi-annually).[1] Corporations usually enlist the help of investment banks, which function as underwriters, to organize the creation, marketing, and sale of the bonds.
EditSteps
EditDeciding to Issue Corporate Bonds
- Consider internal financing first. Internal financing is generally cheaper than seeking outside funding for a project. Conduct a review of your company's financials to uncover areas where you can save money or redirect funds. Some areas to check include within subsidiaries, executive perks, capital expenditure, and recruitment expenses, among others.[2]
- Look into alternative external fundraising options. If you determine that outside funding is necessary, consider selling stock or acquiring a loan. A loan can reliably provide capital to the company, however it can also restrict their activities and may charge a higher interest rate than a bond issuance would. With stock issuances, companies can get even cheaper capital, however now they have sold even more of their equity to investors and may be held responsible for fulfilling investor requests.
- Bonds should not be issued by companies who already carry large amounts of debt, as a bond issuance simply increases debt and makes an already unstable company more so.[3]
- Consider private placement. Private placement involves the selling of unregistered (not registered with the SEC, that is) stocks or bonds to institutional investors. This type of bond may be advantageous to a company as the costs of the issuance are cheaper due to smaller regulatory and marketing costs. However, this type of issuance still requires the assistance of an investment bank, both to file the proper letter of intent and private placement memorandum and to connect the issuing company with institutional investors (large, non-bank funds).[4]
- Calculate the cost of issuing bonds. In order to issue corporate bonds, the company will have to be sure that it is able to make payments on the bonds. That is, future cash flows will have to be substantial enough to cover both the coupon payments every six months or every year and the par value of the bonds when they reach maturity. This will require both a schedule of potential bond payments and the future expenses and earnings of the company.
- The company will also have to factor in transaction costs associated with the issuance of the bonds, which will be charged by the investment bank.
- For these reasons, bond issuances are usually not a good idea for startups, because their revenues may be low or negative for the first couple years of operation, leaving them unable to service their debt obligation.[5]
EditWorking With the Underwriter
- Select an underwriter. The underwriter is an investment bank acts as a middleman between the bond issuer and the investors. The underwriting firm works with your company (the issuer) to begin the process of issuing corporate bonds by determining the specifics of the bond, including when the bonds will mature, the interest rate offered, and the price of the bonds. Both the issuer and the underwriting firm will be represented by legal counsel.
- Investment banks function as underwriters because they have a better understanding of bond market and regulations than the issuer.[6]
- Invite additional underwriters to be involved in the deal. The primary underwriter will invite other investment firms to join the deal. Those who accept the invitation create what is called an underwriting syndicate. Your project is deemed officially "launched" once the syndicate has been formed.
- Forming a syndicate allows the underwriters to reduce individual risk and reach a larger group of potential investors.[7]
- Work with the underwriter to create beneficial bond terms. Bonds are issued with specific durations and the duration and payment frequency of your bonds will depend on your capital needs. In addition, your bond will be rated for risk based on your company's risk profile. The combination of these factors will determine the interest rate on the bond. In addition, market analysis will determine the price on the bond. These are the basic terms of the bond, however there may be others, including:
- Whether or not the bond is secured by the company's assets. These "collateralized" bonds allow investors to claim the company's assets in the event the bond payments go unpaid. Collateralized debt may carry less interest expense for the issuer, as it is considered less risky.
- Callable bonds. These bonds are able to be "called," or paid off, before the maturity date.
- Convertible bonds. These are bonds that can be converted into a set number of the company's shares of stock. Ideally, these allows for the investor to benefit from rising stock prices and the company can then be off the hook for repaying the bonds.[8]
- Write and submit the registration statement to the SEC. The U.S. Securities and Exchange Commission (SEC) requires that corporations who desire to issue corporate bonds submit a registration statement with a prospectus that will outline the price of the bonds as well as what the company will do with the funds they plan to raise with the issue of corporate bonds. Filings with the SEC also include GAAP-compliant financial statements for the issuer, the issuer's type of business, a risk profile of the investment, a management profile, and, later, a list of major investors.
- All of the participants in the deal, including the issuer and members of the underwriting syndicate, work collectively on the language and format of the registration statement.[9]
EditSelling the Bonds
- Price the bonds. Set the final price of the issue after you've sent the registration letter and taken preliminary orders for the bonds. Submit the final pricing to the Trade Reporting and Compliance Engine (TRACE) which is a part of the National Association of Securities Dealers.
- The underwriter should price the bond in accordance with their understanding of the bond market.[10]
- Locate the right market for the bonds. Corporate bonds may be issued publicly or privately. Privately-marketed bonds are known as private placements. However, publicly-issued bonds can also be issued in capital markets or banking markets, or both. Work with the underwriter or underwriting syndicate to determine the best market for your bonds based on the nature of your issuance.[11]
- Market the bonds. The Lead Manger will complete a questionnaire from the Depository Trust and Clearing Corporation (DTC) which will allow you to be eligible for the bonds services that DTC provides, such as distribution and depository. Once your issue has been approved, you can commence marketing and taking orders for your bonds.[12]
- Bonds may be marketed to investors through the underwriters' personal connections or through financial publications like the Wall Street Journal or Barron's.[13]
- Deposit bonds and distribute funds. After you have issued your corporate bonds and deposited them with DTC, the lead underwriter handles the distribution of the bonds to the underwriting syndicates who in turn issue the bonds to investors. After the bonds have sold, the lead underwriter is responsible for distributing the funds to the issuer.
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