A convertible note is debt that the holder can convert into common stock under specified terms. For investment-grade issuers, converts are a cheap way to raise capital. For struggling small-caps, they're often a slow-motion liquidation.
Fixed-conversion vs variable-conversion
Fixed-conversion notes have a set conversion price ($X per share). Variable-conversion notes (a.k.a. 'death spiral' or 'toxic' notes) convert at a discount to the recent market price — often 20–40% off the lowest VWAP of the prior 10–20 trading days.
Toxic converts create a feedback loop: holder converts at a discount, sells immediately, price drops, next conversion is at a lower price, more shares issued, repeat.
How to recognize toxic structure
Search the 8-K and the note exhibit for phrases like 'lowest VWAP', 'variable conversion price', 'discount to market', and 'reset'. Lenders that show up repeatedly in this space include certain specialty finance firms — once you've seen one of these notes, you'll recognize the next one in seconds.
Conversion caps and 4.99% blockers
Most toxic notes include a 4.99% (or 9.99%) ownership cap to keep the holder under reporting thresholds. That doesn't reduce dilution — it just spreads it over more days as the holder converts, sells, and converts again.
Investment-grade converts
Larger companies issue 'plain vanilla' converts: fixed conversion price 25–35% above the reference share price, hedged by the company with a call spread to offset dilution. These behave more like long-dated call options and rarely drive the chart on their own.
What to do
If you see variable-conversion language in an 8-K, treat the stock as actively shorted by the lender until the note is fully converted or repaid. Position size accordingly.
Track the note balance in each 10-Q — outstanding principal divided by current price ≈ a floor on remaining dilution.