Convertible Debt

Convertible Debt is a type of financing where a company issues bonds or loans that can be converted to a predefined number of equity shares at a later date or under certain conditions.

Example

Let’s say you own a flowers company called Rosy Blooms. I give you capital in the form of Convertible Debt with the below specifications:

• Principal: $5M
• Interest Rate: 6%
• Conversion Price: $25 per share
• Current Share Price: $20 per share
• Maturity Date: 5 years from issuance

Now lets say that Rosy Blooms agrees to be acquired by PetalCorp in an all-stock transaction, valuing Rosy Blooms at $50 per share.

Since the share price is above the conversion price, I would convert my debt into equity. The formula for this would be:

Number of Shares from Conversion = $5M / $25 = 200,000

Total Value of Shares = 200,000 × $50 = $10M

Investor Profit = $10M (value after conversion) - $5M (initial debt investment) = $5M

So, I invested in $5M and got $10M in return, a 2.0x MOIC and 100% return.