Market momentum
As we close out the first half of 2025, we are seeing renewed and encouraging energy in the capital markets. While the eight technology initial public offerings (IPOs) that have occurred so far this year are a far cry from the numbers we saw several years ago, there remains a great deal of optimism and enthusiasm from investors and issuers to raise capital and put it to use. Against this backdrop, the convertible debt market has reemerged as one of the most efficient and flexible financing alternatives available to public companies.
Earlier today, Cooley partners Dave Peinsipp, Jason Savich and Rich Segal joined Diana Doyle, managing director and head of technology equity and equity-linked capital markets at Morgan Stanley, to discuss the market forces bringing converts back in a big way, and how both late-stage private and public companies can think about whether this product is right for them.
If you missed the Cooley Market Talks webcast, watch the full replay.
Why converts might be right for you
At its core, a convertible note is simply straight debt that can convert into equity. Investors purchase a traditional unsecured bond – usually with a five-to-seven-year term – along with the right to convert the principal into the issuer’s common stock at a preset conversion price. Some key characteristics that make converts an appealing option include the following:
- Debt with an equity kicker. Think of a convertible as straight debt with a call option. Investors receive downside protection from par repayment at maturity but also have the chance to benefit if the stock price rises above the conversion price.
- Settlement flexibility. Modern convertibles aren’t just limited to converting into equity of the issuer. Most convertibles are now typically issued with “flexible settlement,” allowing the issuer – upon conversion – to deliver any mix of cash and shares. More mature issuers may opt for “net share settlement,” paying cash up to principal and delivering equity for any excess conversion value, which serves to minimize dilution and likely obtain preferred earnings per share (EPS) treatment. As Diana highlighted in Market Talks: “The flexibility is what has made convertible debt be in the conversation. Almost every board we speak to considers convertible debt versus something else.”
- Sparse operating covenants. Unlike typical high-yield bonds or bank debt, convertibles rarely include restrictive operating covenants around debt incurrence, liens or restricted payments. Other than standard covenants regarding public reporting, events of default and provisions regarding fundamental changes, day-to-day operating flexibility is largely preserved.
- Use of proceeds flexibility. Convertible buyers generally accept broad “general corporate purposes” language in the “Use of Proceeds” section of the offering documentation, unlike straight-debt investors who often insist on more explicit disclosure around how the company plans to use the proceeds of the raise. Equity and straight debt investors often have more questions around whether the capital will be worth the dilution or interest expense, but the flexibility around converts often helps hedge those concerns.
- Dilution management. Convertibles are often coupled with concurrent stock repurchases and derivative transactions designed to offset dilution, reduce stock price impact or create artificial stock borrow to improve marketing/pricing. Call spreads (consisting of a separate call option on the stock and a warrant) and capped calls (one instrument that effectively combines the call option and the warrant) are particularly popular due to the ability to tax integrate (i.e., treat the cost of the instrument as original issue discount, thereby reducing the effective up-front cost of the instrument).
This structural versatility – bond economics on day one and equity flexibility on the back end –explains much of the product’s renewed popularity.
Market landscape for convertible instruments
In addition to the flexibility of the instrument itself, low coupon rates coupled with investor enthusiasm and a willingness for new types of issuers to issue them help explain why convertible notes are surging in popularity right now.
- Ultra-low coupons. In 2021, a handful of companies were able to issue convertible notes with 0% coupons, while Department of the Treasury yields hovered near 1%. Today, zero-coupon notes continue to be issued in greater numbers while policy rates hover closer to 5%. As Diana noted in Market Talks: “The fact that you can get a 0% coupon, despite the interest rate environment, and save 600 basis points or more versus straight debt – that’s a differential we haven’t seen in a long time.”
- Investor enthusiasm. In a market with elevated volatility in stocks, issuers can monetize such volatility in the form of better terms. Investors have been willing to pay for volatility, resulting in issuers receiving lower coupons or higher conversion premiums in their convertibles. As Rich offered in Market Talks: “I think we’re over the hump here, and there’s some real momentum. Deals are getting out, deals are trading well. Investors need to feel like they’re making money to want to deploy more money.”
- Diversification of issuers. Where historically the convert market was a product for high-growth companies that didn’t have access to traditional debt (due to not being profitable or an inability to get favorable terms for meaningful size in the straight debt markets), low coupons have brought in more mature and investment-grade issuers who could otherwise go to market with high-yield or investment-grade debt.
- Fresh capital raises. In the technology sector especially, many of the convert issuances in the past couple of years were refinancings from issuers who took advantage of opportunistic terms in share prices at the prior peak of the convertible market from 2020 to 2021. Picking up this year, they now include first-time issuers who have only recently gone public or went public previously without capitalizing on the convertible market opportunity.
Legal considerations and execution mechanics
Fundamentally, a convert is a securities offering just like any other securities offering, such as IPOs or registered follow-ons. Deal execution will look very similar in terms of disclosure and diligence, although converts are usually issued under an exemption from registration under Rule 144A. An issuer will put together an offering memorandum or a registration statement that includes specific offering-related disclosures, a description of notes that specify the terms of the instrument and risk factors. Some other key execution issues to consider include the following:
- Earnings windows and flash numbers. Depending on the timing of the offering, consider whether to include flash numbers in the offering document, while remembering that issuers cannot sell securities while in possession of material nonpublic information (MNPI). If a transaction launches several weeks after quarter end but before the Form 10-Q or Form 10-K filing, it may be prudent to furnish “flash” financial information to “cleanse” the market and provide investors with the information they need to make an informed decision.
- Timeline. The convert market is increasingly window-driven – when the window’s open, the market is hot. And when the market is hot, companies are often looking for creative ways to hit the market while investor enthusiasm is highest. It typically takes companies an average of two weeks to prepare for a convertible, although the actual time exposed to the market is about 24 hours or even overnight.
- Concurrent equity and convert. Though not typical, some companies may consider accessing both the equity and debt markets at the same time by doing a follow-on offering concurrent with a convertible. The benefit is that, for management, this is generally a single preparation process and a single execution process, with marketing for both transactions on the same day with a consistent narrative and story to investors. This may be most compelling if the company has a secondary component in equity and a primary component in convertible debt. It also helps to manage dilution, where the convertible instrument is less dilutive in the upsize scenario compared to having issued all equity. Moreover, debt holders like having an equity component, ensuring that the company will not be overleveraged and preventing its ability to refinance or repay at maturity.
- Remember it is debt. As attractive as convertible debt may be – with its low coupons, flexible settlement and equity upside – it is essential for companies and boards to remember the fundamental truth: It is still debt. As Jason put it: “The biggest reminder: It’s debt. At the end of the day, if things don’t turn out well, you’re going to have to owe the principal back.” While the structure offers strategic advantages, it also carries long-term obligations that require thoughtful planning, especially around maturity, refinancing and potential dilution scenarios.
Looking ahead
Convertible debt is likely to remain a topic of conversation at the capital markets table, offering a solution where straight debt may be too expensive or otherwise unattractive and pure equity too dilutive. Continued equity volatility, a maturing IPO class hungry for potentially less dilutive capital and an upcoming pipeline of maturities ripe for refinancing all suggest that converts may continue for some time. For issuers willing to brave a fast-moving process – and boards comfortable managing the eventual maturity – convertibles remain an attractive product in the market today. As Diana stated in Market Talks: “The IPOs of today are the convertible issuers of the future. I think the convertible market’s going to continue to be hot because it’s compelling to so many different types of companies now.”
Key takeaways
Here are a few highlights from the Market Talks session to keep in mind:
- Convertible debt is no longer a niche product – it is a mainstream, strategic financing tool embraced by companies across sectors and stages.
- Convertibles offer low-cost capital for issuers with an equity upside for investors.
- Issuers benefit from flexible settlement and minimal operating covenants.
- Legal execution mirrors other securities offerings, often under Rule 144A.
- Market timing and MNPI management are critical to success.
- The convertibles market is poised to remain strong into 2026, driven by investor demand, favorable terms and a growing pipeline of companies with existing convertible notes coming to maturity.
