Let’s discuss OCDs.

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Funding a business is essential to expand it. How to get funded is the most crucial. Should one to continue use their working capital or go for next step.

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Company has two sources of capital: (i) Equity and (ii) Debt. But there are certain sources that are in between equity and debt. One such instrument is the optionally convertible bond or optionally convertible debentures, commonly referred to as OCBs or OCDs, respectively.

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For companies, OCDs?provide an avenue to raise funds without diluting ownership significantly. They can generate interest income during the debenture tenure (coupon rate fixed as per the lender post due diligence) and convert the debentures into equity shares when advantageous market conditions or strategic opportunities arise.

An OCD is a bond that can be converted into a specified number of equity shares at the option of the bond holders.

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Under what circumstances would bond holders convert?

In the above example, one bond with Rs.1000 face value can be converted into four shares. That means the effective purchase price of a share would be Rs.250 for the holders of the OCDs.

If the actual market price of the share is more than Rs.250, say Rs.300, then the bond holders can convert the bond into shares and sell the shares in the market. That way, they would be able to receive a higher amount of Rs.1200 i.e., 20% more.

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Why do companies issue optionally convertible bonds?

The most common reason for issuing an optionally convertible bond or a debenture is to provide a higher reward to lenders for taking higher risk.

Another reason for issuing OCD is when there is a lack of consensus between investors and the company on valuation of equity shares. Most often, companies use compulsory convertible debts (CCDs) than OCDs when there is concern on valuation. However, OCDs can also work in certain situations as elaborated later.

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