An Alternative Financing Tool: Convertible Bonds
An Alternative Financing Tool: Convertible Bonds
Author: Fahri Can Dogan, KDK Law Firm
Given the current macroeconomic outlook and the solid impacts of COVID-19 on the Turkish market, it has become much harder for Turkish companies to satisfy their financing needs by accessing conventional financing sources with lower interest rates. Convertible bonds may be considered as an attractive financing instrument for these companies and become an alternative path to raise capital.
Under Turkish law, convertible bonds are regulated under Communique on Debt Instruments numbered VII-128.8 (the “Communique”), issued by the Capital Markets Board of Turkey (the “CMB”). Under the Communique, the convertible bond is defined as a debt instrument that grants its holder an option to either convert such bond into new shares in the issuer company’s share capital at a prescribed conversion price for a certain conversion period or to receive the bond’s principal and the accrued interest. In that sense, convertible bonds can be classified as hybrid security, comprising of both debt and equity elements.
Advantages for Parties
There are several advantages for a company to issue convertible bonds, thanks to their hybrid characteristic. First of all, as the convertible bond provides equity call option right, it generally offers lower interest rates compared to conventional bond issuance, so it enables the company to access a cost-effective financing method. Another important advantage is that this offering allows the issuer to obtain upfront cash for the shares to be issued in the future. Thus, the company can satisfy its financing needs in a swift manner. Furthermore, if the conversion takes place, or the bondholder exercises its equity call option right (generally in a scenario where the share price is increasing), then the issuer can eliminate its obligation to repay the bond’s principal amount at the maturity date.
On the other hand, the convertible bond’s hybrid nature enables its holder to position itself according to the changing conditions in the market. In other words, the bondholder can benefit from advantageous conversion rates in case of an increase in the share prices or stick to the bond’s proceeds (i.e., principal amount plus accrued interest of the bond to be repaid to the bondholder) and protect its investment against the lower share prices. Furthermore, as convertible bonds are issued as senior debt, in a possible insolvency scenario, it gives to the bondholder a priority against the company’s shareholders.
Main Principles of Convertible Bond Offering
- The Communique regulates detailed principles for convertible bond offering in Turkey or abroad. If the offering is to be made as a private placement in Turkey or abroad, the parties can structure the respective transaction with terms and conditions different from the principles stated under the Communique, with the CMB’s prior consent.
- According to the Communique, a convertible bond’s term cannot be less than 365 days, and the parties can exercise the conversion option only after the end of that period. Indeed, the terms and conditions of convertible bond offering generally include a non-call period that aims to increase the share price throughout a specific period after the offering.
- Two elements mainly determine the details of the conversion transaction: the conversion price and the conversion rate. The conversion price indicates the price taken as a basis for the shares to be transferred to the bondholder. The conversion rate shows the number of shares to be transferred to the bondholder in consideration of the convertible bond’s nominal value.
- Convertible bonds can be redeemed by being converted into shares on or before the maturity date. Redemption of bonds before their maturity date can be made either through a redemption plan or an equity call option right to be exercised by the issuer company or the bondholder. In principle, the conversion transaction can be made by increasing the capital. The issuer company can also opt for a contingent share capital increase.
Author: Fahri Can Dogan, KDK Law Firm
Given the current macroeconomic outlook and the solid impacts of COVID-19 on the Turkish market, it has become much harder for Turkish companies to satisfy their financing needs by accessing conventional financing sources with lower interest rates. Convertible bonds may be considered as an attractive financing instrument for these companies and become an alternative path to raise capital.
Under Turkish law, convertible bonds are regulated under Communique on Debt Instruments numbered VII-128.8 (the “Communique”), issued by the Capital Markets Board of Turkey (the “CMB”). Under the Communique, the convertible bond is defined as a debt instrument that grants its holder an option to either convert such bond into new shares in the issuer company’s share capital at a prescribed conversion price for a certain conversion period or to receive the bond’s principal and the accrued interest. In that sense, convertible bonds can be classified as hybrid security, comprising of both debt and equity elements.
Advantages for Parties
There are several advantages for a company to issue convertible bonds, thanks to their hybrid characteristic. First of all, as the convertible bond provides equity call option right, it generally offers lower interest rates compared to conventional bond issuance, so it enables the company to access a cost-effective financing method. Another important advantage is that this offering allows the issuer to obtain upfront cash for the shares to be issued in the future. Thus, the company can satisfy its financing needs in a swift manner. Furthermore, if the conversion takes place, or the bondholder exercises its equity call option right (generally in a scenario where the share price is increasing), then the issuer can eliminate its obligation to repay the bond’s principal amount at the maturity date.
On the other hand, the convertible bond’s hybrid nature enables its holder to position itself according to the changing conditions in the market. In other words, the bondholder can benefit from advantageous conversion rates in case of an increase in the share prices or stick to the bond’s proceeds (i.e., principal amount plus accrued interest of the bond to be repaid to the bondholder) and protect its investment against the lower share prices. Furthermore, as convertible bonds are issued as senior debt, in a possible insolvency scenario, it gives to the bondholder a priority against the company’s shareholders.
Main Principles of Convertible Bond Offering
- The Communique regulates detailed principles for convertible bond offering in Turkey or abroad. If the offering is to be made as a private placement in Turkey or abroad, the parties can structure the respective transaction with terms and conditions different from the principles stated under the Communique, with the CMB’s prior consent.
- According to the Communique, a convertible bond’s term cannot be less than 365 days, and the parties can exercise the conversion option only after the end of that period. Indeed, the terms and conditions of convertible bond offering generally include a non-call period that aims to increase the share price throughout a specific period after the offering.
- Two elements mainly determine the details of the conversion transaction: the conversion price and the conversion rate. The conversion price indicates the price taken as a basis for the shares to be transferred to the bondholder. The conversion rate shows the number of shares to be transferred to the bondholder in consideration of the convertible bond’s nominal value.
- Convertible bonds can be redeemed by being converted into shares on or before the maturity date. Redemption of bonds before their maturity date can be made either through a redemption plan or an equity call option right to be exercised by the issuer company or the bondholder. In principle, the conversion transaction can be made by increasing the capital. The issuer company can also opt for a contingent share capital increase.