Most bonds and loan notes run to a fixed maturity date. But circumstances change. The business might sell an asset early, refinance on better terms, or simply generate more cash than expected. In any of those cases, the ability to repay early is worth having.
That ability has to be written into the terms from the start.
What a call option is
A call option gives the issuer the right, but not the obligation, to repay the bond before maturity. It is usually available from a set date, often after an initial period in which the bond cannot be repaid at all.
Without a call option, the issuer is generally locked in until maturity, paying interest even if it no longer needs the money.
Why investors want something in return
Early repayment is good for the issuer and less good for the investor. Investors committed their money expecting a certain return for a certain period. If the bond is repaid early, they lose the remaining interest and have to find somewhere else to invest.
So call options usually come with protection for investors:
- A non-call period at the start, during which the bond cannot be repaid.
- A redemption premium, meaning the issuer repays slightly more than face value if it calls early, often reducing over time.
- A make-whole provision, which compensates investors for the interest they would have received.
Choosing the right structure
The right terms depend on how likely you are to want to repay early.
If the repayment source is an asset sale that could happen at any point, flexibility is valuable and worth paying for. If the business expects to run the full term, a simpler structure with no call option may attract investors more cheaply.
Other early exits
Some instruments also give investors a put option, the right to ask for repayment early in certain circumstances, such as a change of control of the issuer. Know which rights run in which direction before you sign.
Getting these terms right at the outset saves difficult negotiations later, when circumstances have changed and both sides want different things.
Mark Johnson is the Founder of BDM Capital, which introduces capital raising opportunities across bonds, loan notes, IPOs and SEIS/EIS. To discuss a raise, get in touch.
Frequently asked questions
The issuer repaying a bond or loan note before its maturity date. Whether it is allowed, and on what terms, is set out in the instrument.
The issuer’s right to redeem the bond early on set dates or after a set period, usually at a premium to the principal. It gives the issuer flexibility to refinance if rates fall or the business improves.
Because they lose the income they expected for the remaining term and must find a new home for their money. The premium compensates for that and discourages the issuer from redeeming for trivial gains.
BDM Capital is not authorised or regulated by the Financial Conduct Authority. This article is general information, not financial, tax or legal advice, and does not constitute an offer or invitation to invest. Capital is at risk and you may get back less than you invest. Written for founders and directors of businesses considering a raise. Take independent professional advice before making any investment decision.
