Issuing convertible notes has long been an attractive capital-raising option for public companies. At its most basic essence, a convertible note is a debt instrument that pays interest and principal, but also carries the right to exchange the interest and principal cash streams into an equity interest, typically common stock, of the issuer.
In that sense, a convertible note can be viewed as a debt instrument combined with a call option (a warrant) on the underlying common stock. However, this basic structure has evolved considerably, particularly within the past 20 years, to incorporate several new and sometimes relatively complex features to address changing regulatory and accounting frameworks and investment strategies. To a company contemplating a convertible note offering in the United States, many of these features may seem counterintuitive, and even puzzling.
This primer aims to demystify the underlying financial and accounting principles and the mechanics that have developed to respond to the changing frameworks and strategies.
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