Debt financing basically refers to a business raising capital by borrowing. When a company borrows money to be paid back in coming times with an interest is known as debt financing. It may be in a form of a secured as well as an unsecured loan. Usually, companies take up a loan to either finance working capital or an acquisition. Fascinatingly, in debt financing, the company doesn’t lose its ownership. As per literal meaning, debt is an amount of money that needs to be repaid back and financing means providing funds for use in business activities.
Debt financing is a time-framed activity where the borrower needs to pay back the loan along with interest at the end of the agreed period. The payments can be made on a monthly, half-yearly basis, or towards the end of the loan tenure.
What are the options for debt financing in India?
There are different options available for the companies to generate funding for their business. Some of the options are enumerated below: –
Corporate Bonds: –
Corporate bonds are debt securities that are issued by companies to raise money for a variety of purposes. One has to lend the money to buy a corporate bond, and in exchange, the company issues the bond by promising to return that money. Notably, buying corporate bonds doesn’t give an ownership interest in the company unless the one purchases the equity stocks of the company. Under this method, the funds are raised through either public issues or via private placements.
In public issues, an offer is made to the general public to subscribe to the bond, whereas in private placement such an option is given to a limited number of persons. Such a method of debt financing assists in expanding the sources of financing and reducing the credit risk concentration in the banking sector.
Commercial Paper: –
This is an option for the companies which are looking for short-term funds requirements. This debt instrument is issued in a form of a promissory note. The minimum maturity period of commercial paper is seven days and the maximum is one year from the date of issuance. The companies with high ratings from a recognized credit rating agency often sell these commercial papers at reasonable prices. Generally, the commercial papers are sold at discounted prices for the sake of face value and carry higher interest rates than bonds.
Trade Credit: –
Companies generate money through trade credits by taking advantage of lower global interest rates and the ability to borrow at longer maturities. Trade credits are those credits that are granted by the overseas suppliers, banks, and financial institutions for maturity up to 5 years for imports into India. This credit includes both suppliers’ credit and buyers’ credit depending upon the source of finance. Suppliers’ credit relates to the credit for imports into India granted by the overseas supplier, whereas buyers’ credit is a loan for payment of imports into India arranged by the importer from an overseas bank or financial institution.
Masala Bonds: –
The International Finance Corporation (IFC) launched the Masala bonds to fund infrastructure projects in 2014. Indian companies issue Masala bonds in Indian Currency outside India to raise funds. Both the govt. and private entities can use this debt instrument. The Masala Bonds are also known as “Maharaja Bonds” as their name suggests the Indian culture. Importantly, the money raised through these bonds cannot be invested in real-estate activities and capital markets. Howbeit, these bonds can be used for the development of integrated township or affordable housing projects. The other important condition of these bonds is that these bonds can only be issued to a resident of a member country of the Financial Action Task Force.
Other instruments: –
Apart from these debt instruments, these are some instruments that are being used by the Companies including corporate fixed deposits and non-convertible debentures. Corporate fixed deposits are equivalent to unsecured loans as these instruments do not give any assurance to the investors in case of default. On the other hand, non-convertible debentures are secured and redeemable bonds which are usually issued by high-rated companies in the form of a public issue to accumulate long-term capital appreciation. As compared to convertible debentures, it offers higher interest rates.
The levels of debt begin to look more challenging as the cycle turns with the combination of falling asset prices, a decline of profitability, and turbulent markets. Moreover, with the increasing reliance of Indian companies on foreign borrowings, attracted through the super low global interest rates, the exchange rate has taken on the bigger role in generating stress not only in the foreign exchange markets but also on the overall financial system. These changing circumstances are demanding changes in the formulation of market regulations as well as a system for the operation of the monetary policy.
Associate at Aggarwals & Associates, S.A.S. Nagar, Mohali