Helen Burnett-Nichols
Mary Flory
When it comes to accessing capital, both bonds and loans are useful financial instruments for companies to get the funds they need to invest in new projects and future growth opportunities. Governments also may offer bonds to raise funds.
From a consumer point of view, bonds and loans serve different purposes — one is an investment product that yields interest, while the other is a form of credit that the borrower is required to pay back with interest.
What is a bond?
Bonds are fixed-income products issued by governments or corporations to raise funds. Bonds are essentially loans from the investor to the issuer for a set term, where the issuer promises to pay back the face value on a certain date — known as the maturity date — as well as regular interest, sometimes called coupon payments. Bonds can be either short- or long-term in duration, lasting up to 30 years.
What is a loan?
Loans are lump-sum amounts extended by financial institutions to individuals or companies for a set amount of time. In return, the borrower agrees to repay the full amount, plus interest at a fixed or variable rate, generally in instalments.
Bonds vs. loans: similarities
Both bonds and loans are financial instruments that have set periods, accrue interest and require the borrower to repay the principal. They both have the same end result for a business — a way to access funding.
Bonds vs. loans: differences
While bonds and loans have similar characteristics in that they both result in capital, they work differently. With a bond, the issuer receives money from investors and promises to pay them interest in exchange for their investment. The issuer of a bond pays interest regularly — usually semi-annually — and the principal is repaid at maturity in a lump sum. Bonds are also tradeable in the secondary market.
With a loan, a financial institution lends money to the company or individual, who agrees to repay the principal, as well as interest, in regular instalments over a set period of time. However, interest rates payable to lenders on loans may be higher than the rates corporations pay out on bonds.
When it comes to repayment, loans may offer more built-in flexibility regarding a borrower’s ability to renegotiate terms, payment amount or timeline with the lender. With bonds, the issuer’s responsibility to repay bond principal and interest on a certain date is set at the start of the investment period and typically cannot be revised.
How to choose between bonds and loans
Choosing between bonds and loans for raising capital comes down to a few key questions:
How creditworthy are you?
To issue bonds, companies generally need to have a strong credit rating. Bond rating agencies, such as Moody’s, will assign a rating to the bond. This gives investors an idea of the likelihood of the company meeting its obligation to pay back the principal and make the coupon payments. In a case where bonds are deemed to be of a lower credit quality, the company can use collateral as a backup to the bond.
While business owners generally need good credit to qualify for loans, a lender may also consider the financial health and growth prospects of the business, among other factors. Indeed, according to the Canadian Bankers Association, approval rates for debt financing from financial institutions are high — nearly 91% of all small and medium-sized enterprises that applied in 2020 were approved.
How quickly do you need funding?
Generally, qualifying for a business loan can be a quicker process than issuing corporate bonds, which requires an underwriter or agent, legal counsel and regulatory compliance. It’ is also worth considering how long you’ll need the funding — loans tend to be shorter in duration than bonds.
How important is predictability?
With bonds, companies have the ability to set fixed interest rates and terms, which may make their repayment obligations to investors more predictable. The terms of a loan are ultimately agreed upon between the lender and borrower — if this agreement includes variable interest rates, the amount a company is required to repay may change over time.
Is there a need for flexibility?
With a loan from a financial institution, borrowers may have a chance to refinance or renegotiate repayment terms — an opportunity that does not exist for companies seeking financing through a bond issue, as they are bound by agreed-upon terms with investors.
Frequently asked questions about bonds and loans
For a business, the main difference between a bond and a loan is the source of capital. With a loan, a financial institution acts as the lender. When a company or a government issues a bond, investors provide the capital.
It depends on the terms. With bonds, investors require repayment at maturity, which can represent a large financial responsibility for a company to meet. Yields also may be higher on longer-term bonds or those with lower credit ratings.
As with loans, bonds can come with variable interest rates, which may result in changing repayment obligations to lenders or investors. However, companies ultimately have the ability to decide the terms of the bond, including whether to offer bonds with fixed or variable interest rates.
