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What is Debt Capital?

Debt capital refers to the funds a company secures by borrowing, typically through loans or by issuing bonds. Unlike equity financing, which involves selling ownership stakes, debt must be repaid with interest, creating an obligation. It's a critical tool for growth, but managing it requires strategic finesse. How does this balance impact a company's future? Let's examine the intricacies.
Ken Black
Ken Black

Debt capital is the capital, usually money, raised through issuing bonds. Although most of the time the capital raised is money, it could be other goods of value as well. The capital raised must be paid back to those who finance the debt. Both private companies and governments can raise debt capital this way.

To raise capital, companies have a number of different options. Of course, the purpose of most companies is to sell a product or service for a profit. However, some may need or wish to raise money faster than the normal course of buying and selling will provide. To do that, they may consider debt capital.

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In some ways, this type of capital may be more attractive to a company than another form of raising money, such as an additional stock issue. Companies may not want to issue more stock because that would dilute the ownership of the existing stock. Issuing more stock runs the risk of lowering the stock price as well, depending on how much is issued.

Investors may also find that supplying debt capital through buying bonds is an attractive option. While the option provides no ownership stake in the company, it does offer a bit more security than stocks. Bond payments take priority over dividend payments, which stockholders receive. If the company makes only enough money to cover its debt capital obligations, it is the stockholders who do not receive any payments. As with most other forms of debt, bonds are repaid with interest.

This type of capital is normally raised through a bond issuance, though other options also exist. Companies may also borrow from banks, which is a popular option for many small businesses. However, most larger companies see bonds as a more popular option for a variety of reasons.

In some cases, debt capital may be used to pay debt capital that is already outstanding by issuing more bonds to payoff the first set of bonds. This is called "calling the bonds." Usually, this means the original bonds issued are being paid off before the end of the term. Companies, or governments, may choose to do this because the interest rates are more advantageous at some other point in the life of the bonds.

Debt capital is usually issued after a consultation with a bond attorney, who determines a number of different factors, including how best to sell the bonds. The bonds may be sold through negotiation with one underwriter or through a bidding process. In some cases, especially for governments, bonds may only be allowed to be issued for certain projects. Bond attorneys will inform government administrators on all legal issues.

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Bonds are also common ways for governments to raise money to finance projects. It is very typical for states to finance road projects through bonds and there are even states that get in the business of issuing mortgages through capital generated by bonds.

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