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are equity or debt investments that can be exchanged for something else of value upon the happening of some future event. The most common convertible securities are debentures and preferred stock that are convertible into common stock. The election of the holder is usually all that is required to convert. Convertible securities are a nice way for investors to hedge. They allow them to acquire a debt instrument, for example, with its rights to interest and principal payments, without sacrificing the chance to participate in the company's capital appreciation. When a company does well, the investor can convert his debenture into stock that is more valuable. When a company is less successful, he can retain his debenture and receive his interest and principal payments. Most venture capitalists like convertible securities because they help preserve their capital and give them the potential of profiting from increases in the value of the company's stock. By giving their holders an option for removing money from a modestly successful company, convertible securities help investors preserve their capital even when their portfolio companies are not successful enough to allow them to liquidate their investments through public offerings. Contrary to popular opinion, most venture capital investments do not generate large profits for their investors. Most portfolio companies succeed modestly or fail. Deal structures that include convertible debentures can enable investors to retrieve their capital from their modest successes for reinvestment in other companies. See: Cashing Out (or In), Convertible Preferred Stock, Debentures, Downside, Equity, Liquidity Agreements, Subordinated Convertible Debentures, Upside, Venture Capital Deal Structures. |
