Investing through Convertible Notes

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Do You Understand Investing through Convertible Notes?

In the Australian Financial Review Smart Money section on October 9 – 10 2010 there is an article entitled “Limited choice for retail bonds” (see AFR article).

This article discusses the problems with raising debt through the ASX, the recent ASX rule changes and the reasons why most debt in Australia is raised by borrowing from the banks. There are a number of listed debt securities on the ASX and these are reported daily in the AFR in the Interest Rate Securities section in four groups Corporate Bonds, Floating Rate Notes, Convertible Notes and Hybrid Securities.

The listed debt securities market in Australia is very small for a number of reasons but while reading the article and reviewing the tables of debt securities prices, it brought to mind the question of why so few potential investors in small companies request that they be permitted to invest via Convertible Notes rather than through straight equity.?  Most small companies that are raising capital have limited sources of funds and most would be happy to consider issuing Convertible Notes.

Convertible Notes are debt securities that pay interest like normal loans (although this can usually be deferred to match forecast company cash flows) and they permit the investor to stand:

  • in front of the entrepreneur/existing investors (both for the return of their capital and for income payments) when the actual results are worse than forecast and;
  • alongside the entrepreneur/existing investors when the results match up to or are better than the forecasts by converting the Convertible Notes into equity??.

The rights of the investor using Convertible Notes can be protected in a number of ways including using a trustee (which can be expensive) or acquiring a small number of shares in addition to the Convertible Note and setting up a Shareholder Agreement.

If you would like to discuss investing in a company through using Convertible Notes or if you would like to consider raising capital through issuing Convertible notes, please contact us directly.  Would you like our help? Please call on +61 2 9258 1972 or go to our Contact page.

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