A fixed-rate convertible note converts at a price set at issuance. A variable-rate convertible converts at a price tied to recent market action — typically a discount to a trailing VWAP. The first is a constrained dilution event. The second is a self-reinforcing spiral.
These notes appear almost exclusively on distressed companies that can't access any other capital. The presence of a variable-rate convert is itself a red flag on the equity.
The conversion formula
Typical language: 'lower of $X fixed or 90% of the lowest 10-day VWAP, subject to a floor of $Y.' The holder converts $1 of principal into 1/conversion-price shares.
As the stock falls, the trailing VWAP falls. The conversion price falls with it. More shares are issued per dollar converted. Every conversion adds supply, which pushes the price lower, which lowers the next conversion price. That's the spiral.
Volume restrictions don't save you
Most variable-rate notes cap conversion to a percentage of daily volume — often 20% above a dollar-volume threshold. This paces the spiral, it doesn't stop it.
On high-volume days, the holder can convert and sell larger blocks. On low-volume days, the bleed continues at a slower pace. Either way the direction is one-way.
Case study: CTRM 2020
Castor Maritime, January 2020: $5M note to YA II PN. Conversion price = lower of $2.25 fixed or 90% of lowest 10-day VWAP, floor $0.60.
At the $2.25 ceiling, $5M converts to 2,222,222 shares. At the $0.60 floor, the same $5M converts to 8,333,333 shares — four times the dilution from the same principal.
By March 2020 the annual report disclosed YA II had converted $2.25M into 3,500,785 shares at an average ~$0.66 conversion price, then sold them around a $1.75 VWAP for $6.1M+ on the original $5M investment — with half the note still outstanding.
The holder is price-insensitive
Because the discount is built into the conversion price, the holder profits on any sale above that price. They have no incentive to time the market. They are a guaranteed seller into any strength.
This is what makes variable-rate converts uniquely destructive: classic supply-demand assumes the seller has a reservation price. Here, there is none.
How to spot one
Search the company's 8-K and 10-Q exhibits for: 'variable conversion rate,' 'percentage of VWAP,' 'lowest trading price,' and the lender names that specialize in these structures (YA II PN / Yorkville, GS Capital, Power Up Lending, Auctus Fund, Crown Bridge).
Any hit means the equity is structurally short until the note is fully retired. No squeeze setup overrides this — the convert prints into every rally.