What Is Debt That Raises Capital?

Sometimes, a company may wish to raise capital to finance an expansion or to pay for certain expenses. There are a number of ways in which a company may go about doing this, including opening the company to investors or securing a loan. However, some companies choose to issue debt. This means that the company provides debt obligations to investors in exchange for an agreement to pay them later, usually with interest.

Raising Capital

Even a successful company may not have enough cash on hand to finance an expansion. Occasionally, the company will choose to raise this capital by selling debt to investors. For the investors, the debt takes the form of an investment, as the company is promising to pay the debts back, plus interest. For the company, the capital raised from the sale of this debt functions as a business loan.

Debt Obligations

Debt used to raise capital can take many forms, the most common of which is a bond. A bond is a debt obligation issued by a business or another group, such as a municipal government. Investors agree to purchase these debts in exchange for receiving repayment at a later date. The value of these bonds may fluctuate based on the market's expectation of whether a company will pay back the money it borrows.

Interest Rates

The amount of interest that a company will be required to pay investors to buy the bonds will correlate directly with the company's credit rating. The higher the company's credit rating, the safer an investment the investors will consider the purchase of its bonds. Therefore, these investors will be willing to buy the bonds even if the company offers a relatively low rate of interest. Conversely, less creditworthy entities much pay higher interest rates.

Risks

Issuing debt to raise capital carries many of the same risks for a business that taking out a personal loan does for an individual. When a business takes out a loan, it is essentially wagering that it will have enough capital to pay back the debt when it comes due. If the capital is not used wisely, the company mat find that it cannot meet its debt obligations, which may lead to a lowering of its credit rating.