Published on October 21, 2021
Convertible debt is a common investment vehicle by which early-stage companies raise capital. This is in the form of a short term loan granted from a investor to a company. What makes this loan unique is that the loan can convert into equity of the company at a future date (next priced funding round). In return, the investors receive compensation at the time that the debt converts to equity (dilution).
Typically convertible debt offers interest at a lower rate than straight debt instruments.
A company's total liabilities are the combined debts and obligations that a company owes to outside parties. Everything the company owns is classified as an asset and all amounts the company owes for future obligations are recorded as liabilities.
Convertible preferred stocks are preferred shares (dividend paying) that include an option for the holder to convert the shares into a fixed number of common shares after a predetermined date. These details are covered in the convertible preferred stock agreements, which specify the conversion ratio from preferred to common shares.
Each agreement is unique and may have a different conversion ratio. For example, convertible preferred stock may be exchanged at the request of the shareholder into common stock. However, sometimes there is a provision that allows the company, or issuer, to force the conversion.
A convertible note is a debt instrument that is convertible into shares of the issuing company. Convertibles notes offer the holders the downside protection of a debt instrument and the upside appreciation potential of an equity investment. Many outstanding convertible notes include caps on the number of shares that may be issued upon conversion of the notes.
Convertible note offerings can be conducted as:
A senior convertible note is a debt security that contains an option in which the note will be converted into a predefined amount of the issuer's shares.
Convertible note offerings can be executed relatively quickly with little preparation, in part because they can be effected without SEC registration. FlashSEC will provide you with the most up to date status on these deals.
Death spiral financing is the result of a badly structured convertible financing used to fund mainly small cap companies, causing the company's stock to fall dramatically, which can lead to the company's ultimate downfall due to the forced creation of an ever-increasing number of shares, inevitably leading to a steep decline in the price of shares.
This type of bond may be issued by a company that desperately needs cash. A company that seeks death spiral financing probably has no other way to raise money to survive.
The death spiral effect occurs as more and more fixed-value convertible share/bond owners convert their preferred shares/debt into common stock as their value drops lower and lower. Each additional conversion will cause more price drops as the supply of shares increases, causing the process to repeat itself as the stock's price spirals downward.
As of 10/6/21, $CEI has been involved with Death Spiral Financing. $CEI Series C preferred convertibles have diluted share holders, causing their total outstanding shares and float to increase to over 200 million.
A company that issues this type of convertible bond is probably desperate for cash to stay afloat. Theoretically, the death spiral effect can continue until the stock is at or near zero value.
Some investors may use convertible bonds as a component of an arbitrage opportunity, for example purchasing a convertible bond while taking a short position in the underlying common stock. This can have the effect of putting downward pressure on an issuer’s stock price at the time of a convertible note offering. Most convertible bond investors are large institutional investors and hedge funds.