When it comes to raising money, companies have more options than a stock issue or a simple bank loan. A third way is to borrow funds directly from investors and eliminate the bank as the middleman. When a company issues bonds, it creates one master loan agreement and invites investors to participate in the loan. All investors get the exact same deal regardless of whether they buy one bond or 1,000.
A bond indenture is the master loan agreement between a company and its bondholders. It sets out key terms of the bond issue such as the amount of money the business is borrowing and the interest rate.
How Bond Indentures Works
A bond is another way for a corporation to raise money. It works like a regular loan, with multiple investors giving the corporation a specific amount of money in exchange for interest payments made at regular intervals. The company repays all the loans on a predetermined maturity date. An indenture is the formal contract between a company and the bondholders – think of it as a master loan agreement. It sets out all the conditions of the bonds, such as when they mature, details of the interest rate, timing of payments, redemption terms and any special features.
Indenture Bond Example
Since bonds are issued to multiple investors, it would be impractical for a company to enter into separate contracts with every single one. Instead, it creates a master loan agreement or indenture and all bondholders get the exact same deal. Much of the language has to do with bond specifics, for example, the repayment schedule and interest rate. The indenture should include enough detail to enable interested investors to make an informed investment decision.
Enforcing the Indenture
To handle the day-to-day management of the indenture, the corporation usually appoints a trustee to act on behalf of the bondholders. The trustee is responsible for issuing the bond certificates and making sure the corporation pays interest on time. The trustee will also enforce the bond covenants. These are the positive or negative covenants the corporation must abide by to protect the value of the bond, such as restrictions on taking on additional debt or making new capital investments. If the company breaks the terms of the bond indenture, the trustee can sue the company on behalf of the bondholders.
Why Businesses Use Bonds
Companies often issue bonds when they need to raise cash to finance major projects. There are fewer strings attached than with a bank loan since corporations have the freedom to set their own loan terms. For example, a company might offer bondholders a lower interest rate than it would have to pay to obtain a bank loan, or it may issue bonds over a longer period. A bond issue is also more attractive than a stock issue to many companies, since the issuance of new bonds does not dilute the company ownership.