Convertibles, preferred and toxic financing
Toxic Convertible Notes: How Variable Pricing Works
Toxic convertible notes explained: how variable conversion prices, VWAP discounts and lookback windows work, and what happens to share counts with no floor.
On this page
- What is a toxic convertible note?
- The four moving parts of a toxic convertible
- A worked variable-price conversion example
- Why the discount matters even if the price never moves
- How the terms read in a real filing
- Where to find these terms
- Fixed versus variable at a glance
- How to check a company on Signal8
- FAQ
What is a toxic convertible note?
"Toxic convertible" is market slang, not a legal term. It describes a convertible note or convertible preferred stock whose conversion price moves with the market instead of being fixed when the deal is signed. Traders lump these structures under the label toxic financing, which refers to the deal terms, not to any particular investor or firm.
An ordinary convertible note might say: the holder can convert $1,000,000 of principal into common stock at $5.00 per share. That number of shares (200,000) is known on day one. A variable-price convertible instead says something like: the holder can convert at 80% of the lowest trading price over the last 10 trading days. The number of shares depends on where the stock trades at the moment of conversion, so nobody can state the final share count in advance.
When that formula has no minimum price, the note is a floorless convertible. That combination, a moving price with no bottom, is the core of the structure.
The four moving parts of a toxic convertible
Almost every variable-price conversion clause is built from the same four pieces. Learning to find each one in the agreement is most of the work.
- The reference price. Usually a volume-weighted average price (VWAP), a closing price, or the lowest intraday trade. "Lowest" anything favors the holder.
- The lookback window. How many trading days the reference price is measured over. A lookback period of 10 or 20 trading days, combined with "lowest", lets the holder pick the cheapest day in that window.
- The discount. The VWAP discount is the percentage knocked off the reference price, often written as a percentage of it ("80% of" means a 20% discount).
- The floor, or its absence. A floor price is a minimum conversion price. If the formula would produce a lower number, the floor applies instead. No floor means the conversion price can keep falling as long as the stock does.
This is what variable-price conversion means in practice: the price is an output of a formula, re-run every time the holder sends a conversion notice.
A worked variable-price conversion example
Hypothetical Company X issues a $2,000,000 convertible note. The conversion price is 75% of the lowest daily VWAP in the 10 trading days before each conversion. There is no floor. Company X has 20,000,000 shares outstanding.
The holder converts $250,000 of principal each time, at different points as the stock price changes:
| Conversion | Lowest 10-day VWAP | Conversion price (75%) | Principal converted | Shares issued |
|---|---|---|---|---|
| 1 | $1.00 | $0.750 | $250,000 | 333,333 |
| 2 | $0.80 | $0.600 | $250,000 | 416,667 |
| 3 | $0.60 | $0.450 | $250,000 | 555,556 |
| 4 | $0.40 | $0.300 | $250,000 | 833,333 |
| 5 | $0.25 | $0.188 | $250,000 | 1,333,333 |
All figures hypothetical and rounded.
After five conversions the holder has turned $1,250,000 of principal into about 3,472,222 shares, roughly 17% of the original share count, with $750,000 of principal still outstanding. Notice that the last $250,000 produced four times as many shares as the first. The same dollar amount of debt becomes more shares as the price falls.
To rerun this table with your own principal, discount, lookback, floor and price path, use the convertible conversion calculator.
Why the discount matters even if the price never moves
The discount is not only relevant when the stock declines. Because the holder receives shares worth more than the debt converted (at market prices), there is a built-in spread. If the stock sits at exactly $1.00 for a month and the conversion price is $0.75, each converted share has a market value $0.25 above what it cost the holder in principal.
A holder who sells shares soon after converting captures that spread. Selling in volume can itself weigh on the trading price, which then feeds back into the next lookback window. That feedback loop is why the pattern is often described, in the vernacular, as a death spiral. It is a description of a possible mechanical loop, not a forecast for any given company: plenty of variable-price notes are repaid in cash or converted only partially.
How the terms read in a real filing
Variable conversion terms often sit in the description of notes in an annual or quarterly report, or in default provisions. An amended annual report filed on Form 20-F/A on 2026-10-06 (accession 0001493152-26-045996) described note terms under which, after an event of default, the holder could convert:
From the filing
Form 20-F/A“at a conversion price equal to 80% of the average of the four lowest volume weighted average prices over the preceding 20 trading days, with full-ratchet anti-dilution protection”
What Signal8 extracts:Default conversion price: 80% of the average of the 4 lowest VWAPs over 20 trading days (20% discount, no floor stated)
Form 20-F/A · filed 2026-10-06 · accession 0001493152-26-045996
Reading it piece by piece: the reference price is VWAP, the lookback is 20 trading days, "average of the four lowest" softens a pure "lowest" formula slightly, the discount is 20%, and no floor is mentioned in that sentence. It also adds full-ratchet protection, a separate mechanism covered in the resets guide. The trigger is a default, which is a reminder that a note can look fixed-price on day one and become variable later.
Where to find these terms
- 8-K, Item 1.01 and Item 3.02. The announcement of the financing, with a summary of terms. The full securities purchase agreement and the note are usually attached as exhibits numbered 10.x or 4.x.
- 10-Q and 10-K notes. The 10-Q debt footnote describes each outstanding note, its principal, conversion terms and any amendments since issuance.
- Prospectus or resale registration. If shares issuable on conversion are being registered for resale, the registration statement describes the note again, often with a table of shares issuable at different prices.
Key phrases to search for: "lesser of", "lowest", "VWAP", "trading days immediately preceding", "Conversion Price", "Floor Price", "Variable Price", "default conversion". Other terms that change the count, such as most-favored-nation clauses and partitioned principal, are covered in lesser-known adverse terms.
Fixed versus variable at a glance
| Feature | Fixed-price convertible | Variable-price convertible |
|---|---|---|
| Conversion price | Set at signing | Recalculated at each conversion |
| Maximum shares | Principal ÷ fixed price | Unbounded without a floor |
| Effect of a falling stock | Conversion less likely (out of the money) | Each dollar converts into more shares |
| Typical holder strategy | Wait for the price to rise | Convert and sell continuously |
The last row describes the economic incentive each structure creates, not what any specific holder does.
How to check a company on Signal8
- Open a company's Dilution tab, for example the Dilution tab view, to see convertibles extracted from filings. Where the terms support it, a convertible can carry structural chips such as No conversion floor, Ownership blocker, Balance not disclosed, Partitioned note and No maturity. These describe disclosed terms; they are not a rating. Dilution analysis focuses on small caps, so coverage varies.
- The dilution screener compares companies on dilution-related data.
- Watch new financings arrive on the live SEC filings feed, where 8-K Item 1.01 and 3.02 filings appear as they are filed.
Live screen
Convertible overhang in Signal8 dilution snapshots
FAQ
What makes a convertible note "toxic"?
The word is market vernacular for a structure, not a legal category. It usually refers to a conversion price that resets to a discount to recent trading prices, measured over a lookback window, with no minimum price. Because the share count rises as the price falls, existing holders can be diluted by an amount nobody can state in advance. The label describes the terms; it says nothing about the intentions of the investor who holds the note.
How many shares can a floorless convertible create?
There is no contractual maximum from the conversion formula alone. The practical limits are the remaining principal, the company's authorized shares, exchange rules that cap issuance above 20% without shareholder approval, and any ownership blocker in the note. To estimate exposure, divide the outstanding principal by a range of hypothetical conversion prices.
Is a variable-price convertible always bad for shareholders?
Not necessarily. It can be the only financing available to a small company, and some notes are repaid in cash before much conversion happens. What it does mean is that the eventual dilution depends on the stock price, so the outcome cannot be known from the filing alone. Reading the full terms, including floors, caps and prepayment rights, is the only way to understand the range.
Where is the conversion formula usually written?
In the note itself (often filed as Exhibit 4.1 or 10.1 to an 8-K) under a section titled "Conversion" or "Conversion Price", with defined terms like "VWAP" and "Trading Day" in the definitions section. Quarterly and annual reports summarise the same terms in the debt footnote.
See it on DilutionScan
Companies DilutionScan covers, with the instruments read from their SEC filings. Open one to see each instrument and the filing it came from.
- GNSGenius Group Limited8 warrant series, 1 convertible, 1 ATM program, 3 shelf registrations and 2 completed offerings on file
- SMXSMX (Security Matters) Public Limited Company Ordinary Shares10 warrant series, 8 convertibles, 2 equity lines, 4 shelf registrations, 4 S-1 registrations and 2 completed offerings on file
- MLGOMicroAlgo, Inc. Ordinary Shares2 warrant series, 5 convertibles and 2 shelf registrations on file
- HOLOMicroCloud Hologram Inc. Ordinary Shares2 warrant series, 1 convertible, 3 shelf registrations and 2 completed offerings on file
Terms in this guide
- Toxic financing
- Toxic financing is market slang for financing structures, such as floorless or variable-price convertibles and aggressive price resets, whose share issuance grows as the stock price falls.
- Floorless convertible
- A floorless convertible is a convertible note or preferred stock whose conversion price can fall with the market price without any minimum, so a lower stock price means more shares on conversion.
- Variable-price conversion
- Variable-price conversion is a feature where the price at which a note or preferred converts into common stock resets to a formula based on recent trading prices, often at a discount.
- VWAP discount
- A VWAP discount is the percentage below a volume-weighted average price at which an investor buys or converts into shares under a financing, such as 97% of VWAP or 80% of the lowest VWAP.
- Lookback period
- A lookback period is the window of recent trading days a financing agreement looks back over to set a conversion or purchase price, such as the lowest VWAP in the prior ten trading days.
- Full ratchet
- A full ratchet is the strongest price-reset protection, where a warrant or convertible's price drops all the way to the price of any later, cheaper issuance, however small that issuance is.
- Death spiral
- A death spiral is an informal name for a loop where conversions of a market-priced convertible add shares, the supply coincides with a lower price, and the lower price yields more shares.
- Form 10-Q
- A Form 10-Q is the quarterly report a US public company files for each of its first three fiscal quarters, with unaudited financial statements, due 40 or 45 days after quarter end.
Sources
- SEC accession 0001493152-26-045996 Form 20-F/A, filed 2026-10-06, description of default conversion terms on notes (80% of the average of the four lowest VWAPs over 20 trading days, full-ratchet anti-dilution)
Related guides
- What Is Stock Dilution? How New Shares Affect YouStock dilution explained with worked numbers: what happens to your ownership when a company issues new shares, and where to spot it coming in SEC filings.
- Full Ratchet Anti-Dilution and Price Resets ExplainedFull ratchet vs weighted-average anti-dilution explained, plus price resets, with a worked share-count table as the stock falls from $1.00 to $0.10 per share.
- Beneficial Ownership Blockers: 4.99% and 9.99% CapsHow 4.99% and 9.99% beneficial ownership blockers cap a holder's stake at any moment but not total dilution, explained with a worked convert-and-sell cycle.
- Finding the Lender and Deal Terms in SEC FilingsWhere a financing's terms and counterparty are disclosed, from 8-K Items 1.01 and 3.02 to the securities purchase agreement exhibit, with a phrase checklist.
- How to Trade Penny Stocks Without Getting DilutedA dilution-first guide to penny stocks. How new shares reach the tape, which SEC filings announce them, worked examples, and a 20-minute filing check.
- Prepaid Advance Agreements: How They Become SharesHow a prepaid advance agreement works: cash up front repaid in discounted shares, and how the discount, lookback, floor and triggers set the share count.
Check any ticker for dilution
DilutionScan reads each covered company's SEC filings and lists its warrants, convertibles, ATM programs, shelves and S-1s on one page, with a dilution rating and cash runway.
This guide is from the Signal8 Academy, the research team behind DilutionScan. Educational content only. DilutionScan and Signal8 are not broker-dealers or investment advisers, and nothing here is a recommendation to buy or sell any security.