Convertible securities are another popular way for companies to raise capital. Convertible securities usually take the form of convertible bonds or preferred stock. Their perk is that they can be converted into common stock at the holder’s discretion. On rarer occasions, the company can control when the bonds or preferred stock is converted. Here at Prospectus LLC, we can help with the strategic planning and writing of an offering memorandum regarding convertible securities. We can assist in creating a secure plan for your business while also appealing to the interest of prospective investors.
Why should a business issue convertible securities?
Most businesses in private placement engage in the creation of convertible securities. Many entrepreneurs opt to secure funds using this manner rather than going public or obtaining loans from a bank. One of the key benefits is that convertible securities are more attractive to investors. This is because investors could have the opportunity to make profit by converting their stake in the company to a common stock price that is rising. The attractiveness of convertible securities makes it easier for companies to raise capital. These securities maintain a ratio that decides how much common stock can be obtained from a conversion of a bond or preferred stock.
Conversion Ratio Versus Market Fluctuations
In less frequent occasions, the conversion of these securities may be based on market pricing. As a result, the amount of converted equity an investor receives would fluctuate with the market. Although this is not a prominent way to issue such securities, it is still common. A business would engage in these types of securities to ensure the company’s prosperity. In the case of extreme market price fluctuation, the equity structure of the company would experience heavy losses if the conversion to common stock was simply based on a ratio.
Consequently, convertible securities relying on a conversion ratio are known by unfavorable names such as ratchet convertibles or toxic conversion.
The Risks of Convertible Securities
Although convertible securities provide less risk for investors, they are risky nonetheless. One should still take caution when investing in these securities, even if they are backed by market ratios and not normal conversion ratios. Additionally, the prospective investor should observe the amount of issued shares and the sub-market conversion pricing. This should be done to gauge the company’s capability of raising funds in the short and long term.
The team at Prospectus LLC can help businesses across the globe with the consultation and formulation of documents regarding all types of convertible securities. Please contact us to set up a consultation or to ask questions.
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