Funding Tips: How convertible instruments are useful for raising funds from investors for a private limited company?

Convertible security

Convertibles are securities that can be changed from its initial form into another form, usually bonds/debentures or preferred shares, that can be converted into common stock. In simple terms a convertible security is a financial instrument whose holder has the right to convert it to equity of the same issuer.

Convertible securities possess the cash flow features of both bonds/debentures and stocks

Purpose of Convertible Securities

Convertible bonds/debentures or Preference stocks are issued by the company for the purpose of raising funds, instead of taking loans form financial institutions
For investors, investment in convertible securities will provide protection against losses and give higher income than Common stock

Types of Convertible Securities

1.Convertible Preference Stock

Convertible preference stocks are preference shares that include an option for the holder to convert the shares into a fixed number of common shares after a predetermined date. These preferred stocks are paid dividends at a fixed rate, and additionally, they have the flexibility to convert into equity shares of the issuing entity.

2.Convertible Bonds/Debentures

Vanilla Convertible Bonds/Debentures – These bonds/debentures will provide a choice to investors whether to hold the bond/debenture until maturity or to convert it to stock.
Mandatory Convertible Bonds/Debentures – These bonds/debentures are required to be converted by the investor at the conversion rate and price fixed by the issuer.
Reverse Convertible Bonds/Debentures – These bonds/debentures can be redeemed in cash, or converted to debt or equity on maturity date as fixed by the issuer

Pros and Cons to Investors

Convertible bonds/debentures provide a higher current yield than common stock
Investor can sell the securities in market if the market price is high or they can hold till the maturity to get the face value if the market price is low.
Convertible securities have lower yield compared to non-convertible securities
4.The conversion of securities into common stock will be in the hands of issuer, which makes the investor to forcefully convert the securities to stock when the market value is low

Disclaimer:

“Information contained herein is for informational purposes only and should not be used in deciding any particular case. The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Though utmost efforts have been made to provide authentic information, it is suggested that to have better understanding and obtaining professional advice after thorough examination of particular situation.”

Prepared by : Laxman Yalla
Article Assistant

Prepared On:
8/05/23