Corporate Debt

Overview

Ever wondered how businesses manage money for their expansion, growth, and sustenance? To build new stores, launch new products in the market, or acquire another business? Well, it is a fact that corporations do not always have adequate funds lying in their bank accounts and they either need to be raised from investors by offering shares to the investors or through various debt instruments which comes under the concept of Corporate Debt. 

Meaning and Purpose

Corporate debt is the debt or borrowing issued by a business organization or company to access additional capital for expansion and operations to fulfil operational requirements or growth-related goals. These debt instruments are offered to the investors who in turn purchase these debt instruments. Debt instruments have fixed returns and maturity dates. The investor will receive the principal sum as well as interest generated upon fulfilment of a predefined period known as the ‘Date of maturity’. 

These debts have found a liking in the market as an alternative to equity investments or for diversification of one’s portfolio. Various funds and trusts do not invest in the market as a principle laid down by the corporations. These funds and trusts can opt for debt instruments for better returns and safety. The various types of investors are: Individual Investors, Financial Organizations, Venture Capital Firms, and Private Equity Firms, who generally invest in corporate debt instruments. 

Do you wish to raise funds for a specific purpose? Like setting up a new plant. You can issue debentures either at par value or at a certain premium. Hence, corporate debt offers the benefit of offering steady returns and better liquidity to the investors. Presently, corporate debt instruments like bonds and debentures are popular among investors desiring higher returns with minimal risk.

Corporate Debt

Types of Corporate Debt

Commercial Paper – 

This is a type of corporate debt instrument which allows businesses to raise funds. Commercial Papers are also known as Promissory. They are used to raise capital for short-term financing requirements. Generally, the maturity period is up to 270 days allowing investors to purchase instruments at a discount and later make repayment at the maturity date. 

Debentures – 

Also known as funded debt, debentures are debt instruments procured by investors at a fixed rate of interest and repaid borrowed funds in return. Such debentures could either be supported by collateral or not. 

Convertible Bonds- Convertible bonds are a category of debt instruments issued by companies to either manage their working capital expenses or for any specific projects. There are further sub-divisions of corporate bonds categorized based on factors such as security, equity attributes, interest payments, etc.

Mortgage Bonds – 

Mortgage bonds are secured debt instruments issued by corporations to investors or lenders. Whenever corporations offer mortgage bonds in lieu of certain underlying security (i.e. assets like real-estate) as collateral which reduces the total cost of borrowing.  With certain collateral in place, investors can place their trust in the issuer entity regarding timely interest payments and principal repayments. 

Line of Credit – 

Business organizations with real estate equity and good credit scores can easily access a line of credit from financial institutions. Line of credit is a debt instrument that allows businesses access to a certain fixed amount, to be drawn optionally whenever required and no rate of interest is charged until the funds are drawn. 

How is Corporate Debt beneficial for Corporations

Support Business Growth without any burden on ownership

Generally, entrepreneurs are confused at the initial growth stages to get access to necessary financial resources on their own. Corporate Debt is one of the primary ways to achieve growth without the burden of sharing ownership with any third party, especially in the early stages of business.  At this point, debt could be accessed through credit facilities, bank loans, or venture capital/private equity firms allowing sustained business growth. 

Total cost of borrowing is less than the cost of equity 

It is a fact that the overall cost of debt is lower than the cost of equity as the return on equity for business owners is higher than the return on debt. Taking on more debt leads to a lower equity base resulting in a higher after-tax profit/equity return rate.  

Enables risk mitigation 

Businesses are always advised to diversify their assets to ensure efficient risk management. Hence, corporate debt allows businesses to reduce the likelihood of losing business assets in the event the business venture fails to succeed.

Indicates investor confidence in the business 

Investors who agree to avail corporate debt from a business indicate their confidence in the business’s growth potential.

Brings credibility and long-term business relationships

Corporate debt allows the issuer business company to create long-term business relationships with financiers or investors who sometimes become shareholders in the company (in the case of convertible bonds). Business entities making timely repayment of interest and principal get the benefit of enhanced credibility among investors. Additionally, most financing agreements have certain covenants and reporting requirements that help businesses maintain financial discipline. 

Tax Deductions 

Since loan repayments are considered business expenses they could be availed as tax deductions which could reduce overall tax liability for the business. 

Final Thoughts 

Therefore, Corporate Debt is a concept of finance that allows businesses to navigate through financial difficulties helping them to grow without compromising with their business ownership structure. Raising capital via debt instruments allows issuer corporations to raise capital in a flexible manner, stabilize their finances and guard the business against variable interest rates or economic changes.To know how to increase your credit limit book a free demo with BankKeeping.