Conversion of shares: Overview, definition, and example
What is conversion of shares?
Conversion of shares refers to the process of changing one type of share into another, typically based on predefined terms and conditions. This often occurs in cases where convertible securities, such as preferred shares or convertible bonds, are converted into common shares. Conversion provisions are commonly included in shareholder agreements, corporate charters, or financing documents to define how and when such conversions can occur.
Why is conversion of shares important?
Conversion of shares is important because it provides flexibility for investors and businesses. For investors, it offers the opportunity to convert preferred shares or other securities into common equity, often providing voting rights, dividends, or access to potential capital gains. For businesses, conversion rights can make securities more attractive to investors by offering future equity participation.
Clearly defined conversion provisions protect both parties by specifying terms, such as conversion ratios, triggers, and timelines, reducing the risk of disputes.
Understanding conversion of shares through an example
Preferred to common shares: A venture capital investor holds 1,000 preferred shares in a startup. The investment agreement specifies that each preferred share can be converted into two common shares. If the investor decides to convert all their preferred shares, they will receive 2,000 common shares, gaining more voting rights and equity in the company.
Convertible bond conversion: A company issues convertible bonds to raise capital. Each bond can be converted into 100 common shares if the company’s stock price reaches a specified value. When the stock price exceeds the threshold, bondholders exercise their conversion rights, exchanging their bonds for equity in the company.
An example of a conversion of shares clause
Here’s how a conversion of shares clause might appear in a shareholder agreement:
“The Holder of Preferred Shares shall have the right, at their sole discretion, to convert any or all of their Preferred Shares into Common Shares at a conversion ratio of [Insert Ratio], subject to adjustment for stock splits, dividends, or other corporate actions. The Holder must provide written notice of conversion to the Company at least [Insert Timeframe] prior to the intended conversion date.”
Conclusion
The conversion of shares clause provides a mechanism for transitioning between different types of securities, offering benefits to both investors and businesses. For investors, it ensures flexibility and the potential to participate more fully in a company’s growth. For businesses, it enhances the attractiveness of their securities by offering investors future equity options. Including a clear and detailed conversion clause in agreements minimizes risks, ensures transparency, and aligns expectations between parties.
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.