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Convertible notes
Also called: convertible note, convertible debt, convertible bonds, converts, convertible preferred
Debt that the holder can exchange for shares at a set conversion price, so a loan today can become dilution later.
Explanation
A convertible note pays interest like a bond but can be converted into stock. For established companies the conversion price is usually set well above the share price at issue (often 20% to 40% higher), so conversion only pays if the stock rises. Until then it is debt that must be repaid or refinanced at maturity.
Large issuers often buy a capped call alongside the notes to offset dilution, and the hedge funds that buy convertibles typically short the stock as a hedge, which can push the price down when the deal prices. Mandatory convertible preferred works similarly but converts automatically on a set date.
Small companies sometimes issue a very different kind: notes that convert at a discount to the market price at the time of conversion. Those are toxic, or death-spiral, convertibles, and they can dilute without limit.
Why it matters
The conversion shares are part of the overhang: they cap the upside around the conversion price and add shares if the stock gets there, while the debt remains a claim on cash if it does not.
How Equity Dictionary measures it
Convertible offerings, notes or preferred (including mandatory convertible preferred), are classified as their own deal type and count as equity raises in the financing factor; straight debt never counts as dilution. Shares issuable on conversion are part of the overhang factor.
Related terms
- Toxic financing: Convertible securities whose conversion price floats with the market, so the lower the stock falls, the more shares the holder receives.
- Overhang: Shares that could be added to the market from warrants, options, convertibles and unvested stock awards, which tends to weigh on the share price.
- Warrants: Contracts issued by a company that let the holder buy new shares at a fixed exercise price until an expiry date, often five years out.
- Dilution: The shrinking of each existing shareholder’s ownership stake when a company issues new shares.
- Private investment in public equity (PIPE): A sale of unregistered stock, convertibles or warrants by a public company directly to selected investors, who usually get the shares registered for resale afterwards.
Plain-English summary for research; not legal or investment advice.