Convertible Bonds: An Alternative Source of Funding for Small and Mid-Cap Companies
What are convertible bonds?
Similarly to plain vanilla bonds, convertible bonds also have your standard features like interest rates, maturity date, and they can be traded assuming there is liquidity within the market.
However, there are a few distinguishing features which separate the two and this article seeks to explore these features. The features mentioned are according to Thai law regulated by the Stock Exchange Commission of Thailand.
Unlike plain vanilla bonds which is considered as only debt, convertible bonds are a hybrid product between debt and equity. When sold to investors, the convertible bonds are initially considered as debt, but the investors have the right to convert the bonds into equity at a specific price, also known as the conversion price. This would mean that the company which issues the convertible bonds would have to issue shares in reserve in case the investors use their right to convert the bonds into shares.
This would mean that the companies would benefit two folds, one being from the funds raised during the issuance of convertible bonds, the second being from when investors utilize their right to convert the bonds into share where another influx of funds will enter the company. Although this would lead to a slight dilution in the shares of existing shareholders the funds used for business expansion far outweigh the downside of the dilution effects.
Should dilution be a major issue amongst existing shareholders, there are many conditions the companies can change to minimize the risk of dilution. One being to increase the conversion price which would make it harder for those with the convertible bonds to convert it to stock, however, this would make it less attractive for investors to subscribe to the convertible bonds in the first place.
To solve this issue, many companies globally attach warrants to the convertible bonds to increase the return and make it more attractive to the investor. The warrants also act as another pathway for the companies to retrieve funding.
Why Would Convertible Bonds Be Attractive to Small and Mid-Cap Companies?
In Thailand, small to mid-cap companies are generally the underserved market when it comes to offering debentures. Like every company, their vision would be to grow their business and to do so they require funding to invest in projects with the prospect that the internal rate of return will be higher than the cost of funds. Sometimes it might not be worthwhile for these companies to issue plain vanilla bonds to the public as the costs associated to undergo such a transaction might be too high compared to the funds being raised. With plain vanilla bonds, the regulations would be much stricter given that the product is being offered to the public and high net worth individuals, a credit rating is required which would come at a high cost and consume a lot of time. Underwriters are also required by law, giving the underwriters more bargaining power as to the percentage of fees they can charge.
For companies in Thailand, the issuance of convertible bonds does not require an underwriter.
Underwriting fees could vary depending on the who the company hires, however, when it comes to convertible bonds, investors can invest directly in the company which will then issue bond certificates to the investors themselves. The companies also do not require collateral when issuing convertible bonds. For the issuance of convertible bonds, companies also do not require a credit rating as the debenture is being offered to existing shareholders under the assumption that they are knowledgeable about the company they are currently holding shares to. It is for these reasons that small to mid-cap companies could consider using convertible bonds as a fundraising option opposed to your traditional plain vanilla bonds.