Notice of conversion: Overview, definition, and example
What is a notice of conversion?
A notice of conversion is a formal notification given by a party (usually the holder of a convertible security, such as convertible bonds or preferred stock) to inform the issuer that they are exercising their right to convert their security into another type of asset, typically common stock or equity. This process is called "conversion" and is usually specified in the terms of the security agreement. A notice of conversion serves as the official communication to initiate this change.
For example, if your business has issued convertible bonds, the bondholder may submit a notice of conversion to convert the bonds into shares of your company’s stock, as allowed under the terms of the bond agreement.
Why is a notice of conversion important?
A notice of conversion is important because it formally initiates the process of converting a security into a different asset, usually equity. This provides clarity and ensures that both parties (the holder and the issuer) are on the same page regarding the conversion terms. It also triggers the necessary steps to update the company's records, issue the new shares, or make other required adjustments in accordance with the terms of the conversion.
For SMBs, understanding the notice of conversion is critical to managing equity, dilution, and the impact of convertible securities on company ownership. It also helps maintain proper documentation and avoid disputes related to the conversion process.
Understanding notice of conversion through an example
Imagine your small business issued convertible bonds to raise capital, with a provision that bondholders can convert their bonds into company stock at a set conversion rate. A bondholder decides to convert their $10,000 worth of bonds into shares of your company’s stock. The bondholder would submit a notice of conversion, informing your business of their intent to exchange their bonds for shares. This notice initiates the process of issuing the new shares and updating the company’s ownership records.
In another example, if your business issued preferred stock with the option for the preferred stockholders to convert their shares into common stock, the stockholder would send a notice of conversion to the company to initiate the conversion.
An example of notice of conversion in action
Here’s how a notice of conversion might be referenced in a business transaction or agreement:
“The bondholder hereby submits a notice of conversion to convert $10,000 of convertible bonds into 1,000 shares of common stock at the agreed conversion rate of $10 per share. The conversion will be effective as of [date], and the company shall issue the new shares accordingly.”
Conclusion
A notice of conversion is a formal notice used to communicate the intent to convert a security, such as bonds or preferred stock, into another asset, typically common stock. For SMBs, understanding and managing the notice of conversion is crucial for ensuring that the company complies with the terms of convertible securities, tracks ownership changes, and properly handles equity. This helps avoid misunderstandings and ensures that the process runs smoothly.
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.