Key takeaways
- A convertible note is debt that can be turned into company stock at a set conversion price.
- The conversion premium is how far the conversion price sits above the share price at pricing.
- Conversion can dilute existing shareholders; capped calls are one way companies limit that.
- Most US convertible offerings are sold privately to large institutions under Rule 144A.
When a company announces a convertible note offering, it is borrowing money on terms that let lenders swap the debt for shares later. It is one of the most common ways US growth companies raise capital — and it affects people who own the stock.
How a convertible note works
A convertible note is a bond. The company pays interest (the coupon) and repays the principal at maturity, often five to seven years out. The difference is the conversion option: holders can exchange the notes for company stock at a fixed conversion price. If the stock rises well above that price, converting is worth more than being repaid.
Because lenders get that option, they accept a lower interest rate than on ordinary debt. That is the main reason companies choose convertibles.
The terms to look for
- Size. How much is being raised, and whether the buyers have an option to purchase more.
- Coupon. The annual interest rate. Some convertibles pay no interest at all.
- Conversion rate and price. How many shares each $1,000 of notes converts into, and the share price that implies.
- Conversion premium. How far the conversion price sits above the share price when the notes are priced — often 20% to 40%.
- Settlement. Whether conversions are paid in cash, shares or a mix, which the company may be able to choose.
- Use of proceeds. Growth spending, repaying older debt, buying back shares, or funding a capped call.
Dilution and capped calls
If notes convert into shares, existing shareholders own a smaller slice of the company. To limit that, many companies buy a capped call at the same time: an option trade that offsets dilution up to a higher "cap" price. The cost of the capped call is paid from the offering's proceeds.
Why the stock often moves on the news
Share prices sometimes fall when a convertible offering is announced. Investors may price in future dilution, and some buyers of the notes hedge by short selling the stock. How much it matters depends on the offering's size compared with the company's market value, and on what the money is for.
Where the details are
Most US convertible offerings are sold privately to large institutional investors under Rule 144A. The company announces the launch and then the final pricing, usually in press releases filed with the SEC in an 8-K. The final terms appear in the pricing announcement.
Frequently asked questions
What is a conversion premium?
The percentage by which the conversion price is set above the share price when the notes are priced. A 30% premium means the stock has to rise about 30% before converting beats holding the note.
What is a capped call?
A separate option trade the company buys when it sells convertible notes. It offsets dilution from conversion up to a higher "cap" price.
Why does a stock sometimes fall when a convertible offering is announced?
Investors may worry about future dilution, and some buyers of the notes hedge by short selling the stock. The size of the offering relative to the company's market value matters most.
This guide explains how filings and markets work in general. It is not investment advice.
