Breakthrough Reasons Of Painful Bond Death And Rise Of VC Asset Class

Junk bonds are high-yield bonds either rated poorly by the credit-rating agencies or not rated at all. Smaller, less established companies issue these bonds at a higher interest rate. However, Junk Bonds went out of fashion when Venture Capital skyrocketed during the 1980s.

Surprisingly, VC is faster at acquiring initial funds but requires massive amounts of management's time and takes equity. In contrast, bonds do not cut into equity and typically require far less management time to raise money. So why is no one doing this now?

Popularity

Junk bond financing peaked at the beginning of the 1980s and dried up by the decade's end. One of the main reasons for this is Michael Milken, the Junk Bond King, who by 1989 was facing criminal charges due to alleged securities misconduct. At the same time, companies like Apple, Microsoft, and FedEx were proving the VC asset class.

Takeovers

While some companies used Junk Bonds for growth, much of the bond craze centered around raising funds for hostile takeovers. Several of these companies proved to be excellent investments, while many of them ended in bankruptcy. This did not help the public perception of high-yield bond investing.

Market

Unlike VC, a firm raising cash by issuing bonds must actively sell them. This is usually done through a market. Some are well-known and established, while others are little more than e-commerce sites. Plus, issuing them requires legal assistance, which further cuts into proceeds.

Complexity

When raising funds through VC, the VC firm manages the transaction's complexity. They have done the research, created a repeatable process, and are responsible for fund returns to their Limited Partner investors. In turn, the complexity of a bond raise is mostly on the company that issues it.

Risk

A startup that fails with VC investment is a typical scenario. Many firms will invest in future companies from the same management team. However, failure to pay back the bond principal at maturity or missing interest payments and the stress from investors could become overwhelming. The situation could force the company into bankruptcy and create a public relations nightmare for everyone involved.

Conclusion

Issuing bonds is good if you can sell them quickly and have a proven business model to pay them back. Otherwise, you shift from pitching VC firms to selling bonds on the street. However, at later stages, a bond issue may be effective at raising money without diluting equity.