What Are the Pros and Cons of Debt Capital?

Debt capital is usually understood to be funds that are secured from various types of investors and lenders, then utilized to aid in the launch or expansion efforts of a business or even the support of a government initiative. The type of debt that is accumulated in the pursuit of the capital may be in the form of bond issues, various types of loans, and other financial instruments that must be repaid at some point. Securing debt capital can be advantageous in terms of generating needed funds quickly and easily, but may also have some drawbacks, especially if the repayment terms prove difficult for the borrower.

One of the benefits of debt capital is that there are a number of ways to generate this type of funding. Creating a bond issue is one of the more popular solutions. With this strategy, a business or government entity will structure a bond issue that investors can buy, and over time receive both the principal investment plus some type of interest payment. In the interim, the issuer is able to make use of the collected funds to implement projects that hopefully will be self-sustaining or provide some sort of community value, without imposing any hardship on the borrower’s ability to honor the terms of the bond issue. The investor has the benefit of either receiving periodic interest payments throughout the life of the bond, or receiving a lump sum interest payment when then bond matures and the principal is also repaid.

All sorts of financial bonds may be created as a means of generating debt capital. Government bonds can be used to build highways, develop business sections of town, or even construct new schools or parks that help to increase the property values of different residential neighborhoods. Typically, the benefit of a bond used for these types of financing is not only for the parties directly involved in the investment, but also others who live within the municipality.

While there are many advantages to using debt capital to fund projects, there are also some potential drawbacks. Should the plan for repaying the debt become unworkable for some reason, this means the borrower may have to sell off other assets in order to honor the debt, something that could weaken the financial well-being of the borrower. In addition, unanticipated changes in the economy could lead to expenses that were not originally envisioned. This means that if the debt capital is in the form of a bond issue with a floating rate of interest, and the average interest rate increases significantly, the borrower may find it more difficult to honor the scheduled interest payments. The lender could also be affected adversely, if circumstances require that the borrower call the bond option early, a move that often results in the investor receiving less return for the investment.