What Is Deferred Equity?

Deferred equity is a type of security, such as preferred shares or convertible bonds, that can be exchanged in the future at a predetermined price for shares of common stock. These securities, also known as 澳洲幸运5官方开奖结果体彩网:convertibles, are named as such because o𒅌f their equity component, and the expectation that they will eventually be converted into re🍌gular ownership stakes in a company.

How Deferred Equity Works

Deferred equity is an investment vehicle that gives its owners the possibility to convert the income-paying 澳洲幸运5官方开奖结果体彩网:securities they hold into common shares in a company at some point in the future. Payouts are usually lower than comparable securities without conversion features because they come with an option 🍷to acquire regular units of ownership in a company and all the associated benefits that come with this.

The date of conversion may be determined at the outset, left for investors decide or be at a company’s discretion — occasionally deferred equity will be issued with a 澳洲幸运5官方开奖结果体彩网:call provision, meaning the company can force investors to convert the security into common stock, usually when the stock price rallies to a high level. In any case, if and when the conversion occurs, investors should find themselves acquiring securities with greater potential for 澳洲幸运5官方开奖结果体彩网:appreciation, and all the associated risks, normally at a lower price than what they would have had to𒀰 pay for them on the open market.

The price per share that deferred equity can be converted into common stock, otherwise known as the 澳洲幸运5官方开奖结果体彩网:conversion price, is based on the 澳洲幸运5官方开奖结果体彩网:conversion ratio, which is established at the time deferred equit🉐y is issued and can be found in the bond indenture, in the case of convertible bonds, or in the security prospectus, in the case of convertible🌳 preferred shares.

To calculate the price, it is necessary to divide the 澳洲幸运5官方开奖结果体彩网:par value of the 澳洲幸运5官方开奖结果体彩网:convertible security by the pre-determined co🧔nversion ratio indicating the number of common shares the investor receives for each convertible security. 

Example of Deferred Equity

A convertible bond, one of the most common forms of deferred equity, offers the features of a fixed-income corporate debt security, such as interest payments, alongside the possibility to one day trade this in for stock in a company. Typically, the bondholder will exercise the convertible option and transform the bond to🦂 shares of common stock if the price of the underlying shares rise to 🌼a profitable level, typically 25 percent higher than the price at issuance. 

Selling convertible bonds presents companies with a way to raise money cheaply. Coupons, the annual interest paid on these fixed-income securities, are low beca🐼use they come🌄 with a value-added component.

Each convertible bond has a conversion ratio that denotes the number of shares of common stock the bondholder can receive upon conversion. The ratio may be stable or it might change over the bond’s life, but it is always adjusted for 澳洲幸运5官方开奖结果体彩网:stock splits and dividends. A conversion ratio of 50 means that for every $1,000 of par value, or 澳洲幸运5官方开奖结果体彩网:face value of the bond, the bondholder converts, they will obtain 50 shares🌜 of common stock at a conversion price of $20 per share.

Most convertible bonds have intermediate-term 澳洲幸运5官方开奖结果体彩网:maturities and contain a call provision, forcing investors who wish to convert to do so at that price, even if they would rather wait for a better opportunity. The upside is not unlimited. However, the investor will receive the par value of the bond at maturity, even if the share price falls dramatically, meaning that some 澳洲幸运5官方开奖结果体彩网:downside protection is provided.

Special Considerations

When deciding whether or not to make a deferred equity investment, it's important to be familiar with the specifics of not only the convertible features but also call features. If a company makes the convertible securities callable at or near the conversion price, 澳洲幸运5官方开奖结果体彩网:interest expense is eliminated and the investor receives either return of capital or common stock equal to the initial inv🐓estment.

Deferred e🌺quity can also be sold before conversion. If the stock price is way below the conversion price, the security is likely to trade as a straight bond or preferred share, since the prospects of conversion are viewed as remote. Should the stock price rise, however, th🍌e deferred equity becomes more valuable.