The financing practice of companies has changed significantly in recent decades. There is a growing trend away from borrowing from the company's main bank towards more capital market-oriented alternative forms of raising capital.
In this context, corporate bonds are playing an increasingly important role not only in Germany. Corporate bonds offer companies increased flexibility to meet their financing needs and can be tailored to meet the requirements of specific categories of investors. For this reason, bond issues are particularly popular among small and medium-sized enterprises (SMEs).
In contrast to share issues, bond issues are not subject to a specific legal form. Bonds are fixed-income securities that require the issuer to make regular interest payments and to return the capital provided by the investor. Corporate bonds issued by mid-sized companies are generally repaid at maturity at their nominal value.
In many cases, by issuing bonds - with or without an intermediary bank - German companies can attract a large public. While the bond terms typically exclude an ordinary termination by the bondholder, bonds may be sold on the secondary (stock exchange) market. This tradability of corporate bonds, which is due to their structure as securities, increases their attractiveness to investors. This aspect may be decisive when bonds are designed to target private investors (retail bonds).
In recent times, corporate bond financing is no longer limited only to large industrial companies. Even mid-sized companies are increasingly using bonds as a refinancing tool. The recent strong growth in bond issues has even already prompted the creation of specific exchange segments especially for mid cap bonds. Corporate bonds offer numerous advantages over pure credit financing.
- The issuer can reduce its dependency on conventional types of financing and, thereby, counteract the banks' increasing reluctance to grant credits.
- When structuring interest rates, the issuer can benefit from the currently low interest environment. Although mid cap bonds usually have fixed interest rates, even instruments with flexible interest rates are conceivable. While the former offers the advantage of predictable cash flows, the latter provides increased flexibility to changing general conditions during the term of the bond. In such case, the interest rate to be paid is linked to a reference rate like EURIBOR.
- An issue of corporate bonds can generally be a good way of diversifying the refinancing sources already in use and may even be an alternative to an IPO.
- Moreover, as bonds are generally not collateralized, existing loan collaterals may be used for other purposes.
As corporate bonds are typically divided into so-called partial debentures, varying investment sums may be allocated making corporate bonds attractive to both major and small investors. For the same reason, bonds allow for a broad diversification of an investor portfolio and thereby allow for a very individual form of risk spreading. This is one of the main reasons why investors' interest in bonds is constantly growing: bonds promise higher interest than bank deposits and, from this point of view, also offer an alternative to government bonds.
As bonds qualify as publicly offered securities, their issuance is subject to the prospectus requirement laid down in the German Securities Prospectus Act (Wertpapierprospektgesetz, WpPG). The prospectus must have certain minimum contents and is subject to the approval of the German Federal Financial Supervisory Authority (BaFin license).
Although the WpPG provides for some exemptions from the prospectus requirement, mid cap bonds usually do not meet the preconditions to qualify for such exemptions. In case of a bond issue in Germany, the prospectus must mainly describe the risk factors associated with the bond and the issuer's business activity and provide financial information on the issuer in an easily analyzable and comprehensible form. Utmost care and professional advice are essential when it comes to drawing up the prospectus because an incorrect or defective prospectus may trigger the issuer's liability if an investor has suffered damage as a result of the information provided in the prospectus.
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