Corporate Bonds: The Undiscovered Road to Business Growth
In the business world, it happens that a very good idea is killed by the author himself when he is disappointed that the project did not receive bank financing. There is no collateral, cash flow, just a good business project and faith in it - but that's not enough for the bank. In such cases, the gap can be filled in by several alternative financing methods. One of them is bonds. A classical tool that allows businesses to grow up to a stage when banks are interested in it.
I will be open: the bonds market in Lithuania is still lagging. There are at least a number of reasons, but some of the infamous stories when companies did not return the bonds they borrowed have made a great impact. It seriously damaged this part of the financial market at the very beginning of its formation. But in other parts of the world bonds are being successfully issued and a larger part of the debt in capital markets is in the form of bonds.
In fact, bonds are another form of borrowing alongside the usual ones like credit or leasing. We are talking about the same debt, but the terms and conditions for borrowing - pledge, repayment terms, is it easier or harder to borrow - are different. One of the most important goals of the bond issue is to help grow and at the same time minimize the restrictions of business entity actions. Of course, you need to pay for the freedom, so interest rates on bonds are usually higher than on bank loans. Recently, there has been a significant increase in the demand for financial instruments of such return and risk profile in Lithuania. The conditions for developing them are favorable: there are a lot of individuals on the market who would be willing to lend and many individual businesses that need to borrow. Bonds are an instrument capable of catering such needs.
One of the major advantages of bonds is that their issuer has a clearly defined deadline for the completion of the borrowed project. This means that during the project, the developer does not feel the same pressure as if one had borrowed at the bank when it comes to paying monthly credit and interest payments. In the case of bonds, the debt can be paid at maturity and the interest payment can be adjusted flexibly. Bonds do not restrict the companies as much as share capital does.
Debt-related bonds allow you to focus on and achieve the final result, although the company does not have a secured cash flow or collateral required by the bank. Thus, it creates an opportunity to operate for business niche participants, implement promising or highly innovative projects while remaining a business owner and staying unrestricted by monthly credit payments to the bank or control faced by the new shareholders.
Bonds are effective as bridge financing: business is grown at the stage when it can go to the bank. It is important that the bonds provide the opportunity to borrow for Lithuanian small and medium-sized enterprises with a turnover of 50 to 250 million euro. It is an opportunity to borrow for companies without history, capital, collateral but with a good business plan. The bond owner is concerned about the final result and gives time to the developer to implement the project.
The biggest and most noticeable bonds drawback is a relatively expensive borrowing. But at the second glance, mathematics is not so disappointing. Suppose a real estate company is implementing a project. The bank will probably require that it has its own land with construction permits, detailed plans and other attributes - it accounts for about 25-30% of total costs for such business. Everything that is available is pledged to the bank and it actually finances construction. During the development of the project, it is necessary to repay the loan monthly together with interest. What does this mean for real estate developer? This means that until he sells a certain number of real estate units (e.g. apartments), there will be no revenue, only costs. In addition, interest is paid on the total loan amount, although only a small part of the funds may be used.
The bond model offers an alternative: the amount required for a project is borrowed for a certain period. The amount received can be used by the developer at its own discretion, he knows how much the bondholders will be paid at the end of the term and the interest might not be paid during the project. Interest rates on bonds will not change until the maturity whereas bank interest rates are unpredictable. The project is completed, a certain number of apartments are sold, the debt is repaid.
It should be acknowledged that the interest rates on bank loans and bonds differ considerably: in Lithuania, which is classified as high-risk country, where the business is relatively young, the interest rates on bonds amounts to 12% on average. At the bank, one could expect 4-5%. And yet: you can borrow cheaper; however, you will need to pay halfway – but from whose money? "Cheap" is inappropriate in this case, the whole financing logic should be taken into account, and it is as follows: it is arithmetically cheaper to borrow the same amount in the bank, but after evaluating the cash flows of the project, the bond advantage is often higher.
If the developer really believes in his business idea, then the bonds may eventually bring the business to the traditional capital markets. Moreover, bond buyers, especially foreigners, have their own links and connections with other countries' markets, and thus the issuer expands his sales opportunities.
Looking at the global examples, a bond issue can be an important tool for testing market assessments and reactions to major shocks or crises. The world's giant Volkswagen AG in 2015 has faced one of the biggest scandals in the history of the automotive industry – the so-called "dieselgate". The scandal's damage to the reputation of the group was enormous, trust in the company's communication has fallen, the yield on previous bonds has risen sharply. However, Volkswagen has taken actions - began to radically change its priorities and has planned a major electric vehicle program. Did the market believe? Volkswagen recently issued 500 million euro-denominated 3-year bonds and successfully distributed at just 0.35% annual interest. That's the answer.
The credit market is not just banks or bonds, it is a mutual process. The bond market works well in Germany, Scandinavia, whereas the growth of it in the Baltic States is slowed down by the common thinking - if the bank did not lend, then the project is doomed and the alternatives are forgotten. Even if they are remembered, only the interest is considered and the logic behind it is not going to be seen. Time to discover bonds.
Author: Ruslanas Andrejevas, CEO of „Lewben Investment Management“
Article published at: https://www.vz.lt/finansai-apskaita/2018/06/25/imoniu-obligacijos-dar-menkai-pramintas-kelias-i-verslo-auginima#ixzz5MQmeqoRU
Corporate Bonds: The Undiscovered Road to Business Growth
In the business world, it happens that a very good idea is killed by the author himself when he is disappointed that the project did not receive bank financing. There is no collateral, cash flow, just a good business project and faith in it - but that's not enough for the bank. In such cases, the gap can be filled in by several alternative financing methods. One of them is bonds. A classical tool that allows businesses to grow up to a stage when banks are interested in it.
I will be open: the bonds market in Lithuania is still lagging. There are at least a number of reasons, but some of the infamous stories when companies did not return the bonds they borrowed have made a great impact. It seriously damaged this part of the financial market at the very beginning of its formation. But in other parts of the world bonds are being successfully issued and a larger part of the debt in capital markets is in the form of bonds.
In fact, bonds are another form of borrowing alongside the usual ones like credit or leasing. We are talking about the same debt, but the terms and conditions for borrowing - pledge, repayment terms, is it easier or harder to borrow - are different. One of the most important goals of the bond issue is to help grow and at the same time minimize the restrictions of business entity actions. Of course, you need to pay for the freedom, so interest rates on bonds are usually higher than on bank loans. Recently, there has been a significant increase in the demand for financial instruments of such return and risk profile in Lithuania. The conditions for developing them are favorable: there are a lot of individuals on the market who would be willing to lend and many individual businesses that need to borrow. Bonds are an instrument capable of catering such needs.
One of the major advantages of bonds is that their issuer has a clearly defined deadline for the completion of the borrowed project. This means that during the project, the developer does not feel the same pressure as if one had borrowed at the bank when it comes to paying monthly credit and interest payments. In the case of bonds, the debt can be paid at maturity and the interest payment can be adjusted flexibly. Bonds do not restrict the companies as much as share capital does.
Debt-related bonds allow you to focus on and achieve the final result, although the company does not have a secured cash flow or collateral required by the bank. Thus, it creates an opportunity to operate for business niche participants, implement promising or highly innovative projects while remaining a business owner and staying unrestricted by monthly credit payments to the bank or control faced by the new shareholders.
Bonds are effective as bridge financing: business is grown at the stage when it can go to the bank. It is important that the bonds provide the opportunity to borrow for Lithuanian small and medium-sized enterprises with a turnover of 50 to 250 million euro. It is an opportunity to borrow for companies without history, capital, collateral but with a good business plan. The bond owner is concerned about the final result and gives time to the developer to implement the project.
The biggest and most noticeable bonds drawback is a relatively expensive borrowing. But at the second glance, mathematics is not so disappointing. Suppose a real estate company is implementing a project. The bank will probably require that it has its own land with construction permits, detailed plans and other attributes - it accounts for about 25-30% of total costs for such business. Everything that is available is pledged to the bank and it actually finances construction. During the development of the project, it is necessary to repay the loan monthly together with interest. What does this mean for real estate developer? This means that until he sells a certain number of real estate units (e.g. apartments), there will be no revenue, only costs. In addition, interest is paid on the total loan amount, although only a small part of the funds may be used.
The bond model offers an alternative: the amount required for a project is borrowed for a certain period. The amount received can be used by the developer at its own discretion, he knows how much the bondholders will be paid at the end of the term and the interest might not be paid during the project. Interest rates on bonds will not change until the maturity whereas bank interest rates are unpredictable. The project is completed, a certain number of apartments are sold, the debt is repaid.
It should be acknowledged that the interest rates on bank loans and bonds differ considerably: in Lithuania, which is classified as high-risk country, where the business is relatively young, the interest rates on bonds amounts to 12% on average. At the bank, one could expect 4-5%. And yet: you can borrow cheaper; however, you will need to pay halfway – but from whose money? "Cheap" is inappropriate in this case, the whole financing logic should be taken into account, and it is as follows: it is arithmetically cheaper to borrow the same amount in the bank, but after evaluating the cash flows of the project, the bond advantage is often higher.
If the developer really believes in his business idea, then the bonds may eventually bring the business to the traditional capital markets. Moreover, bond buyers, especially foreigners, have their own links and connections with other countries' markets, and thus the issuer expands his sales opportunities.
Looking at the global examples, a bond issue can be an important tool for testing market assessments and reactions to major shocks or crises. The world's giant Volkswagen AG in 2015 has faced one of the biggest scandals in the history of the automotive industry – the so-called "dieselgate". The scandal's damage to the reputation of the group was enormous, trust in the company's communication has fallen, the yield on previous bonds has risen sharply. However, Volkswagen has taken actions - began to radically change its priorities and has planned a major electric vehicle program. Did the market believe? Volkswagen recently issued 500 million euro-denominated 3-year bonds and successfully distributed at just 0.35% annual interest. That's the answer.
The credit market is not just banks or bonds, it is a mutual process. The bond market works well in Germany, Scandinavia, whereas the growth of it in the Baltic States is slowed down by the common thinking - if the bank did not lend, then the project is doomed and the alternatives are forgotten. Even if they are remembered, only the interest is considered and the logic behind it is not going to be seen. Time to discover bonds.
Author: Ruslanas Andrejevas, CEO of „Lewben Investment Management“
Article published at: https://www.vz.lt/finansai-apskaita/2018/06/25/imoniu-obligacijos-dar-menkai-pramintas-kelias-i-verslo-auginima#ixzz5MQmeqoRU
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