Raise long-term funding through debt capital markets

Most businesses fund expansion by reinvesting their existing profits, or securing bank or equity finance. However, an alternative option for medium and large businesses in need of long-term finance is to raise money through bond markets.

By making use of bond markets – also known as debt capital markets – it may be possible for your business to raise substantial funds. There are several different ways you can access finance through these markets.

Finance options include issuing corporate bonds, private placements and securitisation of assets. This guide looks at debt capital markets as a whole, plus the differences between these three options, and the main pros and cons of each.

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How bond finance works

There are a variety of reasons why your business might look at securing bond finance.  It may be to fund the purchase of large assets – such as new buildings or equipment. Alternatively, it could be to secure a longer-term funding structure within your business – giving access to long-term working capital or funding for greater investment in the business.

Like a loan, a bond is a formal contract to repay borrowed money with interest at fixed intervals. On top of the regular interest payments, there will also be a specified date when the debt will mature and the full amount of the bond will be paid back to the investor.

Both the bond and stock markets work on a similar structure – where sellers (businesses) and interested buyers (investors) are placed together to meet their respective financing and investment needs. Banks also play a significant role as market makers. Banks underwrite – ie accept liability for – stocks and bonds issued by businesses to help bring them to market.

If you issue a bond, you are not selling ownership of your business. Though like shares, once bought, bonds can be traded by investors on the public market. However, this is not true for private placements – where the intention of the investor is usually to hold the private placement until maturity.

When someone buys your business’ bonds they become one of your business’ creditors. This means that, in the event of liquidation, they will have a claim on the company that ranks level with other creditors – unless the bond was issued with security on specified assets.

Types of bond finance

There are a number of ways you can access funding through bond markets – also known as debt capital markets. These include:

• corporate bonds – see the page in this guide on raising finance by issuing corporate bonds
• private placements – see the page in this guide on raising finance through private placements
• securitisation – see the page in this guide on raising finance through asset securitisation

Who invests in bonds?

Bonds play an important role in investors’ portfolios – by offering them an opportunity to diversify their investments and expand into new markets.

Institutional investors – eg pension funds, banks and insurance companies – invest in a wide range of assets, which includes significant investment in corporate bonds. Institutions may invest directly in corporate bonds or through funds – which allow them to diversify their investment over a range of businesses.

Investment and finance companies – often representing groups of private individuals – also invest in capital markets.

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Raising finance by issuing corporate bonds

Corporate bonds are used by many companies to raise funding for large-scale projects – such as business expansion, takeovers, new premises or product development. They can be used to replace bank finance, or to provide long-term working capital.

The minimum issue size for corporate bonds is around £100-200 million. However, the private placement market can be used to accommodate smaller transactions.

The main features of a corporate bond are:

• the nominal value – the price at which the bonds are first sold on the market
• the interest rate paid to the bond owner – this is usually fixed
• the redemption date – when the nominal value of the bond must be repaid to the bond holder

Bonds can be sold on the open market to investment institutions or individual investors, or they can be placed privately. For more information, see the page in this guide on raising finance through private placements.

If bonds are sold on the public market, they can be traded – similar to shares. Some corporate bonds are structured to be convertible, which means they can be exchanged for shares at some point in the future.

Advantages of issuing corporate bonds

Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. They can also offer a way of stabilising your company’s finances by having substantial debts on a fixed-rate interest. This offers some protection against variable interest rates or economic changes.

Other advantages of using bonds to raise long-term finance include:

• not diluting the value of existing shareholdings – unlike issuing additional shares
• enabling more cash to be retained in the business – because the redemption date for bonds can be several years after the issue date

Disadvantage of issuing corporate bonds

There are also some disadvantages to issuing bonds, including:

• regular interest payments to bondholders – though interest may be fixed, the interest will usually have to be paid even if you make a loss
• the potential for your business’ share value to be reduced if your profits decline – this is because bond interest payments take precedence over dividends
• bondholder restrictions – because  investors are locking up their money for a potentially long period of time, they can impose certain covenants or undertakings on your business operations and financial performance to limit their risk
• ongoing contact with investors can be somewhat limited so changes to terms and conditions or waivers can be more difficult to obtain compared to dealing with bank lenders, who tend to maintain a closer relationship
• having to comply with various listing rules in order to increase the tradability of the bonds listed on an exchange – particularly, an obligation to make information on the company publicly available at the issue stage and regularly during the life of the bond

Additionally, although it isn’t a mandatory requirement, having a credit rating can help you launch a successful bond issue. However, this is time consuming and will be an added cost to issuing the bonds.

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Raising finance through private placements

A private placement – or non-public offering – is where a business sells corporate bonds or shares to investors without offering them for sale on the open market. These investors could be insurance companies or high-net-worth individuals.

By selling corporate bonds you can raise funds for expanding your business, to finance mergers, or to supplement or replace bank funding. Raising funds in this way offers benefits such as providing stability through long-term investment and protecting the value of your business’ shares. For more information on the advantages and disadvantages of corporate bonds, see the page in this guide on raising finance by issuing corporate bonds.

By using private placements, you can raise a significant amount of finance, and often quite quickly. Unlike a public offering of either bonds or shares, there is no need for a detailed prospectus. A private placement doesn’t need to involve brokers or underwriters and instead they can usually be arranged through banks or specialist financial institutions.

Advantages of using private placements

There are several advantages to using private placements to raise finance for your business. They:

• allow you to choose your own investors – this increases the chances of having investors with similar objectives to you and means they may be able to provide business advice and assistance, as well as funding
• allow you to remain a private company, rather than having to go public to raise finance
• provide flexibility in the amount and type of funding – eg allowing a combination of bonds and equity capital, with amounts ranging from less than £100,000 to several million pounds
• allow you to make a return on the investment over a longer time period – as private placement investors will be prepared to be more patient than other investors, such as venture capitalists
• require less investment of both money and time than public share flotations
• provide a faster turnaround on raising finance than the venture capital markets or public placements

As a result, private placements are sometimes the only source of raising substantial capital for more risky ventures or new businesses.

Disadvantages of using private placements

There are also some disadvantages of using private placements to raise business finance. For example, there will be:

• a reduced market for the bonds or shares in your business, which may have a long-term effect on the value of the business as a whole
• a limited number of potential investors, who may not want to invest substantial amounts individually
• the need to place the bonds or shares at a substantial discount to compensate investors for their greater risk and longer-term returns

Additionally, although it isn’t a mandatory requirement, having a credit rating can be an advantage. However, this is time consuming and will be an added cost to the process.

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Raising finance through asset securitisation

Securitisation allows you to raise finance for your business by selling assets or income streams into a special purpose vehicle (SPV). Securitisation is the process of pooling the assets – typically small assets that it wouldn’t be possible to sell individually – and the SPV is the legal entity created by these bundled assets.

The SPV then raises money for your business to pay for these assets by issuing secured bonds. Usually assets sold into an SPV have some form of regular income – such as royalties, regular payments from customers or other ongoing revenues.

This method of raising finance is often used by businesses in non-financial sectors to support bond issues and raise cash for expansion, acquisition or to reduce bank debt. These sectors could include:

• logistics
• utilities
• leisure
• healthcare
• intellectual property

Securitisation is suitable for a wide range of businesses, as long as they have an asset or collection of assets that:

• can demonstrate regular and consistent cashflow
• can be bundled together and sold into an SPV

Advantages of securitisation

Usually, securitisation is used for raising large amounts of funding and can be advantageous to your business if you are looking for investment. For example:

• the SPV is entirely separate from the originating business
• generally, the interest rates payable on securitised bonds sold by an SPV are lower than those on corporate bonds
• private companies get access to wider capital markets – both domestic and international
• shareholders can maintain undiluted ownership of the company
• intangible assets such as patents and copyrights can be used for security to raise cash
• the assets in the SPV are protected, even if your business gets into financial problems – which reduces the credit risk for investors
• an SPV usually has an excellent credit rating – so regulated investors (such as insurance companies and pension funds) will find it easier to buy bonds than from a private company

Disadvantages of securitisation

There are also some disadvantages to consider. For example:

• it can be a complicated and expensive way of raising long-term capital – though less expensive than full share flotation
• it may restrict the ability of your business to raise money in the future
• you could lose direct control of some of your business assets – this may reduce your business’ value in the event of flotation
• it may cost you substantially if you want to take back your assets and close the SPV

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