Function

• A convertible note is a debt security that can be converted into equity, or shares of stock, at the noteholder's discretion or upon the occurrence of certain events. As a debt security, the notes pay regular interest and have a fixed maturity date. Convertible notes are a type of convertible bond. Notes are most often shorter term debt instruments with maturities of five years or less, and bonds will have maturities of 10 years or more.
  
  

Significance

• Convertible notes are often issued as senior convertible notes. This is a way for a corporation to obtain intermediate term financing at a lower interest cost. The senior feature puts noteholders ahead of other creditors if the issuing company goes bankrupt. The convertible feature allows noteholders to convert the notes to common stock if the stock price increases significantly. The combination of features allows the corporation to pay a low rate for borrowing. For example, in March 2010, Priceline Inc. issued $500 million of senior convertible notes that paid an interest rate of 1.25 percent.
  
  

Potential

• Convertible notes are also used as a tool to raise funds for new corporations seeking venture capital. These are companies with a new product or idea which need money to fund the business' startup and pay expenses until it begins generating profits and is ready to sell stock on the market. The convertible notes used in venture funding give noteholders the first rights to exchange the notes for stock when the company is ready to have an initial public offering of stock.
  
  

Effects

• Convertible notes are often used to raise money through private offerings. For example, Priceline's convertible notes were a private offering. The use of convertible notes in venture capital provides private parties and venture investors who can provide larger amounts of money the rights to convert to stock in the issuing company.
  
  

Considerations

• Investors who want to invest in convertible notes have the best access through mutual funds or closed-end funds that specialize in convertible securities. These funds will research and buy convertible notes, preferred stock and bonds for their portfolios. All convertible securities offer the benefits of regular interest income plus potential price appreciation of the stock which the note converts to significantly increase in value.