What does a convertible mean in practice?
A convertible initially works as a loan on which the company pays interest according to the terms. At a certain time or event, the holder has the opportunity to convert the debt into shares, often at a price set in advance or according to a set model.
If conversion does not take place, the loan is repaid according to the terms. This means convertibles can offer some downside protection while also providing upside if the company grows.
Important terms in a convertible
A convertible is governed by specific terms that determine how and when conversion can take place.
- Conversion price or calculation model
- Date or period for conversion
- Interest rate and term of the loan component
- Terms if conversion does not take place
- How the convertible affects the ownership structure
When these terms are clear, it becomes easier to assess both the risk and the potential of investing through convertibles.
When convertibles are used as a financing solution
Worth bearing in mind
Convertibles are often used when a company wants to raise capital without immediately diluting existing owners. For investors, they can be a way of first earning interest on a loan and later, if the company develops well, converting the loan into shares.
This type of financing is common in growth companies, where the valuation can be hard to establish at an early stage. Convertibles then create flexibility for both the company and investors.
Frequently asked questions
Why do companies use convertibles?
They give the company capital immediately and allow share ownership later, which can be convenient when the valuation has not yet been set.
How do I make money from a convertible?
Through interest during the term and any increase in value if the loan is converted into shares.
Are convertibles risky?
Yes. If the company performs poorly, both the loan and a future shareholding can lose value. The terms are important to review.
Do I decide myself whether the loan is converted?
It depends on the agreement. Some convertibles give the investor a choice, while others convert automatically on a certain event.
Are convertibles common in unlisted companies?
Yes. They are often used to finance early growth phases, when traditional loans can be harder to obtain.