Many of the small \"dot-com\" companies got financing in the form of an instrume

Question

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 (but slightly lower than you would expect) interest amount. But debtholders have the right to convert it to equity at some point in the future.    Why do you think these companies chose this instrument? Do you think it was a good idea?    Does convertible debt offer the same advantages to larger, more established companies such as Exxon Mobil?    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.

Explanation / Answer

Strat up companies have less funds and more cash outflows in the form of establishment, salaries, advertisement, promotional expenses etc., but they have less funds at their disposal, also the people or banks lending them are not sure about the viability of the business of these companies, therefore, they see that risk involved in funding these companies is more and as a result they charge higher interest on the loans they grant. So, these convertible debt could serve as as excellent oppurtunity for these kind of companies. These have two sided benefits, for these startup companies, they get funds at low cost,thereby helping them to establish themselves in the market and concentrate more on business than worry about funds crunch. For the convertible debt holders, they always have the advantage of converting the debt to equity, when ever they see that the company is making profits and they would earn more by converting to equity than by having the instruments in the form of debt, and mean while they anyway earn interest on the convertible debt though less than ususal interest rates.

Convertibel debt is of not much benefit from the point of view of ;big companies, as these companies can raise funds at low cost as these are already established companies, and by raising funds through convertible debt is not advantageous for these companies as the equity gets diluted which is of more value than the debt.

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