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Toxic financing
Also called: death-spiral financing, death spiral, variable-rate convertible, floorless convertible
Convertible securities whose conversion price floats with the market, so the lower the stock falls, the more shares the holder receives.
Explanation
A typical toxic note converts at a discount, often 20% to 35%, to the lowest trading price of the previous 10 to 20 days. The holder converts part of the note, sells the shares, converts again at the new, lower price and repeats. Each round pushes the price down and raises the number of shares the next conversion produces: the death spiral.
Warning signs in the filings: a “variable conversion price” or “alternate conversion price”, original-issue-discount notes from small lenders, default penalties that raise the balance, large share reserves, repeated proposals to increase authorized shares, and serial reverse splits to keep the price above $1.
Nasdaq’s shareholder-approval rule for discounted issuance above 20% and its limits on serial reverse splits restrain these deals on exchanges, so the most aggressive structures are found mainly among OTC companies, though variable-price features still turn up in listed micro-caps.
Why it matters
Once a death spiral starts, existing holders are usually diluted many times over, and the share price can fall more than 90% while the company stays in business.
How Equity Dictionary measures it
There is no single toxic-financing flag; it shows up in the score as a combination: share growth of 100% or more a year (the historical-dilution factor scores 90), convertibles in the overhang, two or more reverse splits in 24 months (listing compliance scores 90) and going-concern language.
Related terms
- Convertible notes: Debt that the holder can exchange for shares at a set conversion price, so a loan today can become dilution later.
- Reverse stock split: Combining existing shares into fewer, higher-priced ones, for example 1-for-10, usually to lift the share price back above an exchange minimum.
- Authorized shares: The maximum number of shares a company’s charter allows it to issue; issuing more requires shareholders to approve a charter amendment.
- Dilution: The shrinking of each existing shareholder’s ownership stake when a company issues new shares.
- Equity line of credit (ELOC): A facility in which an investor commits to buy up to a set amount of a company’s new shares over time, at the company’s request, at a discount to recent prices.
- 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.
Plain-English summary for research; not legal or investment advice.