CONVERTIBLE INSTRUMENTS

WHAT ARE CONVERTIBLE INSTRUMENTS?

• It is an investment that can be changed into another form ( dilutive potential ordinary shares)
• Convertible instruments are issued by a company that wants to raise money.
• It receives cash from investors and the investor have the right to either take the cash back as
redemption or convert to shares or equity.
• They are mostly used by emerging companies
• Examples include convertible debentures and convertible preference shares.
 THE LIABILITY AND EQUITY ELEMENT

• Liability – there is obligation to pay back in Equity – In the event the investor ( loan giver )
wish to become a shareholder.
the event the investor doesn’t want to convert
the debt into equity.
 CONVERTIBLE DEBT

• Debt that converts to equity

• The background is that a company wants to raise funds but doesn’t want to sell equity right
away. It creates a loan so that the investor gives the company a loan which converts to equity in
future at a discount rate.
• A discount rate is figured into the loan because that’s the compensation given to the investor for
taking the risk.
• Investor gets a percentage that compensate him for that risk taken and the compensation is the
discount.
 EXAMPLE

• Nicola invested $500 000 into Bridge Ltd a new company worth $ 1m dollars that had started
operating in Chicago a month ago. She was offered a discount rate of 10% of her loan. After a
few months of satisfactory operations Bridge limited attracted a new investor Tom who decided
to invest 1.5 million. In his view after his investment the company will be worth $3 million. He
then demanded a 50% ownership.
Solution
 We have our original debt of $500 000, which in this case is supposed to be our convertible
instrument.
 CHART OWNERSHIP

• Tom will own 50% of the company

• Bridge limited will own 31.5%
• Nicola will own 18.5%
 CALCULATION OF EPS

Attributable Earnings divided by number of ordinary shares

• Since incorporation, Solar city has had an issued share capital of 500000 ordinary shares, the
company issued 500000 12% debantures with a nominal value of $1 each on 30 june 2002, all of
which are mandatorily convertible( there is no option for cash settlement) into 500 shares on 30
june 2005.
• Solar city's profit for the year amounted to 442 000 for the year ended 2004
• Eps = earnings/weighted average number of shares in issue
• Eps= 442 000/1000000 = $0.44