Interstocks

Interstocks refer to a financial instrument used primarily in the context of corporate restructuring, particularly in leveraged buyouts (LBOs) or mergers and acquisitions (M&A). The term describes a hybrid security that combines elements of both debt and equity, often issued by a special-purpose acquisition company (SPAC) or a holding company to facilitate a transaction. Unlike traditional debt or equity, interstocks typically offer a fixed return to investors, similar to debt, but may also include equity-like features, such as participation in residual value or upside potential.

Interstocks are commonly structured as subordinated notes or preferred shares with conversion rights, allowing investors to benefit from the success of the target company while mitigating some of the risk associated with equity. They are often used when a company seeks to raise capital without diluting existing shareholders excessively or when debt markets are restrictive. The instrument’s value is tied to the performance of the underlying business, making it attractive to investors seeking a balance between stability and growth.

The use of interstocks gained prominence in the 1980s during the leveraged buyout boom, where they were employed to finance acquisitions by providing a middle ground between high-yield debt and equity financing. Over time, their application has expanded to include other corporate restructuring scenarios, such as spin-offs or recapitalizations. However, interstocks remain relatively niche compared to conventional debt or equity instruments, primarily due to their complexity and the specialized nature of their issuance.

Investors considering interstocks should carefully evaluate the terms of the instrument, including conversion rights, subordinated status, and the financial health of the issuing company. As with any hybrid security, interstocks carry risks, including potential dilution, credit risk, and market volatility, which must be weighed against their potential returns. Regulatory oversight and disclosure requirements also apply, ensuring transparency in their issuance and trading.