Alternative Sources Of Corporate Finance: Convertible Bonds

In an age of tight credit and nervous stock markets, alternative sources of corporate finance are becoming increasingly important. Indeed, maintaining liquidity in the general economy is essential. There are several potential forms of non-bank, alternative financing suitable for small to mid-cap companies. These would include:

private equity invoice discounting asset based securities Islamic finance convertible bonds What is a convertible bond?

A convertible bond is an unsecured debt instrument issued by a corporate entity usually a company listed on an internationally recognised Stock Exchange.

The instrument pays a fixed annual coupon and the principal amount of the bond is either repaid at maturity or converted prior to maturity into a fixed number of shares in the issuer, usually at a premium to the issuer's share price at the time of issue.

Normally the bond is issued by the listed company itself and is convertible into its shares however the bond is sometimes structured through a ring-fenced subsidiary Special Purpose Vehicle ('SPV') with SPV's obligations guaranteed by the listed holding company and conversion into the listed holding company's shares. Such SPV's are often formed in an offshore jurisdiction, particularly the main domiciles covered by Appleby. Convertible bonds are generally rated, listed on a recognised bond Exchange market and publicly traded by global institutions active in the secondary convertible bond market.

Convertible bonds are traditionally issued by multi billion pound market capitalisation companies - recent examples include; BA, 3i, Tui, WPP and Aegis.

The market has started to open up to smaller fully listed companies and the larger market capitalisation companies on AiM e.g. Sportingbet Plc and Lonrho Plc.

What are the attractions of convertible bonds for issuers?

Source of fixed rate medium term debt that is usually cheaper than standard corporate bond debt because of the potential vale of the embedded equity option. Issuer is effectively issuing equity at a premium as the conversion price is fixed at a premium of typically 20-30% of the issuer's current share price compared with the typical discount in conventional pure equity issues. Process is fast with an abbreviated road show and limited distraction of management time. Unsecured debt obligation with limited restrictive covenant provisions. Access to a different constituency of institutional investors-convertible bonds are purchased by specialist...