The cryptocurrency landscape is a vast area, where new developments happen almost every day. Many beginners are entering the market without having a proper understanding of the landscape. To navigate through the crypto realm, you have to comprehend different terminologies and concepts. One such concept is the convertible senior notes. Convertible senior notes are a unique financial instrument that blends characteristics of both debt and equity, allowing investors to convert their holdings into shares of the issuing company. These notes are prioritized over other debts, offering a layer of security to investors.
In this article, we will discuss the convertible senior notes and how MicroStrategy uses them to buy Bitcoin.
What are Convertible Senior Notes?
Convertible senior notes are certain debt instruments that many companies use to raise capital without instant dilution while providing investors with the opportunity to convert their debt into equity under favorable circumstances. Simply put, these are certain types of debt security that you will be able to convert into shares of the stock of the issuing company.
The term senior refers to the fact that whoever holds the notes has more importance than the debt holders in terms of repayment if the company files for bankruptcy. You must be aware of the following important words related to convertible senior notes.
Principle amount: The principal amount refers to the money borrowed by the company initially.
Interest rate: It is the fixed interest rate paid on the principal amount.
Maturity date: The principal amount must be repaid before this date.
Conversion price: The note can be exchanged into shares of the company’s common stock at a fixed price per share. This is known as the conversion price.
Conversion ratio: The number of shares of common stock that each note can be exchanged into is known as the conversion ratio.
There are many reasons why a company establishes these notes. Let’s look at the reasons:
- Convertible notes enable companies to obtain funds during the initial phase such as the startup stage or uncertain times.
- When compared to conventional equity financing that sells shares, convertible notes won’t instantly dilute the ownership stakes of shareholders.
- In certain circumstances, interest payments on convertible notes allow companies to deduct their tax amount.
How MicroStrategy Use Convertible Senior Notes to Buy Bitcoin?
Michael Saylor, co-founder of MicroStrategy, has adopted a strategy to raise funds to purchase Bitcoin on a large scale with the help of the issuance of convertible senior notes. Let’s look at how this company uses convertible senior notes to buy Bitcoin.
Establishing Convertible Notes: MicroStrategy has issued convertible senior notes more than once to obtain money. These notes usually feature zero-coupon structures, which means they don’t pay interest on a regular basis, and fixed maturity dates. When MicroStrategy initially acquired Bitcoin in 2020, it invested $250 million in cash. Since then, it has raised nearly $3 billion in convertible notes.
Using Proceeds to Buy Bitcoin: The main purpose of the money raised by these notes is to buy Bitcoin, which greatly expands MicroStrategy’s Bitcoin holdings. Around 402,100 Bitcoins, or 1.915% of the 21 million Bitcoins in total supply, are held by the corporation as of December 3, 2024.
Utilizing the Potential of Bitcoin: MicroStrategy aims to take advantage of the long-term growth prospects of cryptocurrencies by making significant investments in Bitcoin. For example, if Bitcoin prices climb, the company’s Bitcoin holdings will be worth more, which might raise MicroStrategy’s stock (MSTR) price.
Leveraging this strategy has significantly benefited MicroStrategy, by achieving an annual return of 80% from 2020 to 2024. The middle of 2020 has witnessed the exponential growth of MicroStrategy, with outperforming many major U.S. stocks.
Advantages of Convertible Senior Notes
Convertible senior notes are beneficial for organizations seeking to obtain money effectively while maintaining flexibility and reducing equity diluting. Let’s look at the major advantages of convertible senior notes.
- The notes’ zero-coupon structure allows companies to pay interest periodically, minimizing the financial costs of the company.
- The advance costs of convertible senior notes are comparatively lower than those of conventional debt or equity issuance.
- The instrument helps MicroStrategy to obtain money easily without diluting the equity of existing shareholders instantly.
- Convertible senior notes are appealing to investors who require recognition of their company’s regular business and Bitcoin assets.
Disadvantages of Convertible Senior Notes
- MicroStrategy’s Bitcoin holdings value has been impacted by substantial changes in price, affecting the financial performance of the company.
- Since the regulatory landscape of cryptocurrency is uncertain, it raises additional risks to the company.
- MicroStrategy relies on the long-term profitability of Bitcoin. If the price of Bitcoin falls suddenly, it will affect the company negatively, leading to significant debt pressure.
- The financial strain on businesses issuing hybrid instruments may increase due to growing borrowing costs, particularly in an environment where interest rates are rising.
Also Read: What Is a Crypto Whale & How Do They Affect Crypto Markets?
Conclusion
Convertible senior notes serve as a powerful tool for companies like MicroStrategy to raise capital while providing investors with an attractive risk-return profile. As the cryptocurrency market evolves, such financial instruments will likely play an increasingly significant role in corporate financing strategies aimed at digital asset acquisition.