Conversion price: Overview, definition, and example
What is conversion price?
The conversion price refers to the price at which a convertible security, such as a convertible bond or preferred stock, can be converted into common shares of the issuing company. It is a key term in the conversion feature of convertible securities and determines how many shares an investor will receive upon conversion. The conversion price is typically set at a fixed amount or a premium above the current market price of the company’s common stock at the time the convertible security is issued. The conversion price can influence the attractiveness of the convertible security to investors, as it defines the potential upside for converting the security into common stock.
For example, if an investor holds a convertible bond with a conversion price of $50 per share, they can convert the bond into common shares at this price, regardless of the stock's current market price.
Why is conversion price important?
The conversion price is important because it directly impacts the value of a convertible security and the investor’s potential return. A lower conversion price offers a more favorable opportunity for conversion, as it allows the investor to acquire shares at a price below the market value of the stock, potentially leading to capital gains. For companies, the conversion price is strategically set to balance the attractiveness of the convertible security to investors with the potential dilution of existing shareholders when the securities are converted into common stock. Additionally, the conversion price helps determine the cost of financing for the company, especially when raising capital through convertible bonds or other instruments.
Understanding conversion price through an example
Let’s say a company issues convertible bonds with a conversion price of $100 per share. If the company’s stock price rises to $120 per share, the bondholder can convert their bonds into shares at the $100 price, effectively purchasing stock at a discount. If the bondholder chooses to convert, they could benefit from the $20 per share increase in value.
In another example, a startup issues convertible preferred stock with a conversion price of $10 per share. If the company’s stock price later rises to $25 per share, the preferred stockholder can convert their shares into common stock at the $10 price, gaining a significant return by acquiring the stock at a lower cost than the current market value.
An example of a conversion price clause
Here’s how a conversion price clause might appear in a convertible bond agreement or preferred stock issuance:
“The holder of the Convertible Bond shall have the right to convert the bond into common shares of the Company at a conversion price of $50 per share, subject to adjustment as described in this Agreement for stock splits, stock dividends, or other corporate actions.”
Conclusion
The conversion price is a crucial element in the structure of convertible securities, influencing both the potential return for investors and the dilution of existing shareholders. By setting the conversion price, companies define the terms under which investors can convert their securities into common stock, while investors use the conversion price to assess the value and potential benefits of conversion. Understanding the conversion price is key for both companies issuing convertible securities and investors considering these investment opportunities.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.