Convertible bonds are debt securities that may be issued by a company. After the end of its maturity, the security holder has the right to convert the security into a stock of the company that issued the convertible bond. Although convertible bonds are defined as a capital markets instrument under the Turkish Law. Both public and private companies may issue such bonds. However, the procedure differs significantly as public companies may issue these bonds to public as a public offering.
Startups as a newly established company often need financing. They meet their financial needs through grants, angel-investor and bank loans. Nevertheless, such financing methods may become insufficient and obtaining bank loans may be challenging when the interest rates are high. For that reason, tech startups may use convertible bonds as a financing method as at the end of the maturity, it is not mandatory pay the principle and the interest; the bondholder would get shares from the company.
As per the Turkish Commercial Code numbered 6102 and dated 14.02.2011 (“TCC”), a General Assembly decision is required for the issuance of a debt security. However, General Assembly may also authorize the Board of Directors of the company to resolve on issuing debt securities. Such authorization may be granted for a maximum of fifteen (15) months.
Communiqué on Debt Securities dated 07.06.2013 and numbered 26870 (“Communiqué”) stipulates the provisions regarding the issue of debt securities in general and specifically convertible bonds. In accordance with the Communiqué, the maturity of the convertible bonds cannot be less than 365 days. The earliest time that a convertible bond can be converted into shares is 365 days following the commencement. The conversion of the convertible bonds to the shares of the company is conducted based on the nominal value of the convertible bonds. In addition, provided that it is stated in the issuance certificate, the amount of interest payable on the conversion date would be also added to the nominal value of the convertible bonds.
Convertible Bonds and Share Capital Increase
Since convertible bonds, at the end of the maturity date, give the bondholder the right to own shares at the company issued such bonds. As such, a share capital increase would likely to happen if there is no share transfer between the company and the bondholder indicated in the convertible bond. As per the TCC, a newly introduced share capital increase concept, conditional share capital increase is introduced. Conditional share capital increase enables bond holders of certain debt instruments such as convertible bonds or other similar bonds or its employees to exchange debt claims with shares of the company. Bondholders are considered creditors of the company that issued the convertible bonds and thus, they may benefit from the provisions of conditional share capital increase.
In accordance with the TCC, the general assembly is entitled to decide on a conditional share capital increase by amending the articles of association of the company. However, amendment does not constitute a share capital increase. Share capital increase is realized at the exact time of the conversion of the convertible bond. In accordance with the TCC, i) value of the conditional capital increase; ii) number, nominal value, and type of each share to be issued to bondholder; iii) person(s) who are be entitled to exercise the right of conversion; iv) privileges to be granted to shares that are going to issued; v) restrictions on transfers of newly issued shares and vi) restriction of the right of first refusal of the existing shareholders and the content of such restriction. Following the conversion, increase of share capital would not need to be registered to the trade registry. Nevertheless, the issuer company may buy its own shares and transfer such shares to the bondholder at the end of the maturity. This method would prevent the dilution of the shares of other shareholders.
Convertible bonds may prove a useful financing method for technology startups as it would be a less risky financial method compared to bank loans. The same however, cannot be said for the investor as the return may be much lower compared to other debt securities, especially the ones that pay interest.