Chapter 8 • Sources of long-term finance
8.6 Convertible loan notes
Convertible loan notesare securities that bear all of the features of loan notes, which
we have just discussed, except that at a pre-stated date they may be converted by the
holders, at their discretion, into ordinary shares of the same business. The conversion
rate is usually expressed as so many ordinary shares in exchange for £100 nominal value
of loan notes. If there are any splits or bonus issues of ordinary shares during the life
of the loan notes, the conversion rights are usually adjusted to take account of them.
Convertible loan notes are an example of a financial derivative.
The UK oil exploration businessPremier Oil plcmade a convertible bond issue in
June 2007. The issue raised funds of £127 million. The bonds have a coupon rate of
2.875 per cent p.a. and are convertible at the rate of £15.82 per share. In other words,
the bondholders will be able to convert £15.82 worth of bonds (at nominal value) for
one of the business’s ordinary shares.
Convertible issues have not been popular over recent years, though a number of
businesses are partially financed by them.
Since convertibles are a hybrid of loan notes and equities, the factors important both
to the issuing business and to potential investors will basically be those that we have
already considered. However, a couple of features of convertibles are worth mentioning.Issue costs
The fact that loan notes are cheaper to issue than are equities means that convertibles
may be a cheap way to issue ordinary shares, particularly where the business is keen
to have some loan finance in any case.Borrowings are self-liquidating
There is no need for the business to find cash to redeem the loan notes since they are
redeemed with ordinary shares. This does not, of course, make them free. Issuing
shares to redeem loan notes represents an opportunity cost to the business and its
existing shareholders. Convertible loan notes tend to be used to raise finance where
investors prefer to have the security of loan notes, with the option to convert to equity
should the business perform well.8.7 Warrants
Warrantsare, in effect, options granted by the business that entitle the holder to sub-
scribe for a specified quantity of ordinary shares, for a specified price at, or after, a
specified time – usually several years following their issue.
The business would usually issue the warrants in one of two ways:l sell them, in which case it would derive a cash inflow; or
l attach them to a loan notes issue as a ‘sweetener’ or incentive to investors to take
up the loan notes.Where a business attaches the warrants to loan notes, which is probably the most
common means of issuing them, the arrangement very much resembles a convertible,‘
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