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Financing for Small dot-com Companies: Convertible Debt or Debentures?

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Many of the small "dot-com" companies got financing in the form of an instrument called convertible debt. This is like ordinary debt, in that it pays a regular interest amount. But debt-holders have the right to convert it to equity. Why do you think these companies chose this instrument? Do you think it was a good idea?

Remember: there's no 'free lunch'. If a company offers creditors an option to convert the bond into stocks it must be giving them something of value. It should get something in return.

(You may of course browse for 'convertible debentures' on the web.)

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Solution Preview

Dot-com companies most likely use the convertible debt or convertible debentures method to increase capital while paying lower interest rates, without having to use the company's current assets to do so. "Convertible debentures are different from convertible bonds because debentures are unsecured; in the event of bankruptcy the debentures would be paid after other fixed income holders. The convertible feature is factored into the calculation of the diluted per-share metrics as if the debentures had been converted. Therefore, a higher share count reduces metrics such as earnings per share, which ...

Solution Summary

This solution discusses the advantages and disadvantages of using convertible debt and debentures in 340 words. Two references are provided.