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Why should you consider convertible debt in your capital structure?

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Convertible debt is a type of financing that allows investors to lend money to a company and later convert it into equity. It is often used by startups and growth-stage firms that need capital but want to avoid dilution or valuation issues. In this article, you will learn why you should consider convertible debt in your capital structure, and what are the main benefits and drawbacks of this option.

本文章的要点总结

Lower capital costs:

Convertible debt typically has a lower interest rate than traditional loans. This helps companies save on financing costs while providing investors with the potential for equity conversion.### *Preserve ownership:Using convertible debt allows companies to raise funds without immediate dilution of existing shareholders. This maintains control and voting rights until the debt is converted into equity.

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Hanan Hasbullah

Senior Accountant @ Coreo Real Estate |…
Vivek Sharma

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1 What is convertible debt?

Convertible debt is a hybrid security that combines the features of debt and equity. It is a loan that pays interest and has a maturity date, but also gives the lender the right to convert it into shares of the company at a predetermined price or rate. The conversion can be triggered by certain events, such as a new round of funding, an IPO, or a change of control. Convertible debt can be issued as bonds, notes, or preferred stock.

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2 Why use convertible debt?

Convertible debt can be an attractive option for both companies and investors, especially in uncertain or volatile markets. It can lower the cost of capital, reduce the risk of default, avoid or postpone valuation conflicts, and preserve ownership and control. The interest rate is usually lower than that of regular debt or equity, and the conversion feature adds value to the lender. The company can repay the debt with equity instead of cash, and the lender can benefit from the upside potential of the company. Furthermore, the company does not have to set a fixed price for its shares at the time of issuing the debt, and the lender can defer the decision to convert until more information is available. Additionally, the company does not have to give up voting rights or board seats to the lender until conversion, and the lender can choose to remain a creditor if the company performs poorly.

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Vivek Sharma

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Some of the reasons why CD can be attractive: 1. Convertible debt provides flexibility to both the issuer and the investor. The issuer can raise funds without diluting ownership, while the investor can benefit from the potential upside of the company’s equity. 2. Convertible debt is often more attractive to investors than traditional debt instruments because of the potential for capital appreciation. 3. Unlike equity financing, convertible debt does not immediately dilute the ownership of existing shareholders.

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Hanan Hasbullah

Senior Accountant @ Coreo Real Estate | Head of Finance
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Using convertible debt offers a unique perspective in finance. It combines the benefits of debt and equity, making it an appealing choice for businesses. As an accountant, you'll appreciate its simplicity in accounting while providing flexibility for companies to access capital and align with investors' interests.

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3 What are the drawbacks of convertible debt?

Convertible debt is not a perfect solution and there are certain drawbacks to consider. These include the potential for a mismatch between the interests of the company and the lender, as well as dilution of existing shareholders when conversion occurs. Additionally, convertible debt can complicate the capital structure, with multiple classes of securities and different rights and preferences, as well as potential conflicts among stakeholders. Lastly, it may trigger tax implications for both the company and the lender, depending on the terms of the debt.

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Hanan Hasbullah

Senior Accountant @ Coreo Real Estate | Head of Finance
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Convertible debt offers flexibility, but be mindful of potential dilution, valuation complexities, interest payments, and investor confusion. As an accountant, precision in accounting is key in managing these nuances

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4 How to structure convertible debt?

Convertible debt can be structured in a variety of ways to meet the needs and preferences of the company and the lender. Interest rates, maturity dates, conversion prices, conversion ratios, and conversion triggers are all elements to consider. For example, the interest rate can be fixed or variable, paid in cash or accrued and added to the principal amount. The maturity date can be short-term or long-term, and it can be extended or accelerated under certain circumstances. The conversion price can be set at a discount or a premium to the current or future market price, and it can be adjusted for stock splits, dividends, or other events. The conversion ratio can be fixed or variable, and it can be based on a percentage or a formula. Additionally, the conversion trigger can be voluntary or mandatory, and it can be based on time, performance, or external factors.

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Hanan Hasbullah

Senior Accountant @ Coreo Real Estate | Head of Finance
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When structuring convertible debt, precision is key. Define clear conversion terms, set a competitive interest rate, choose a reasonable maturity date, and establish conversion triggers. As an accountant, meticulous planning and documentation are vital in this process.

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5 What are some examples of convertible debt?

Convertible debt is a popular financing option for startups, growth-stage firms, and established companies. Examples of convertible debt include SAFE (Simple Agreement for Future Equity), KISS (Keep It Simple Security), and CB (Convertible Bond). SAFE is a simple contract that gives the lender the right to receive equity in a future round of funding at a discount or valuation cap, without interest or maturity date. KISS is similar to SAFE, but can have interest and maturity date, as well as different terms for equity and debt scenarios. CB is a bond that pays interest and has a maturity date, but also gives the lender the option to convert it into shares of the company at a fixed price or rate, usually before or at maturity.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Why should you consider convertible debt in your capital structure?

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1 What is convertible debt?

2 Why use convertible debt?

3 What are the drawbacks of convertible debt?

4 How to structure convertible debt?

5 What are some examples of convertible debt?

6 Here’s what else to consider

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