Unexercised convertible securities: Overview, definition, and example
What are unexercised convertible securities?
Unexercised convertible securities refer to financial instruments, such as convertible bonds, convertible preferred stock, or convertible warrants, that give the holder the right, but not the obligation, to convert the securities into a predetermined number of shares of common stock at a set price. These securities are considered "unexercised" when the holder has not yet chosen to convert them into common shares. The decision to exercise the conversion typically depends on factors like market conditions, the price of the underlying stock, and the terms of the security itself.
For example, a convertible bond holder might choose not to exercise their option to convert the bond into shares if the market price of the stock is below the conversion price.
Why are unexercised convertible securities important?
Unexercised convertible securities are important because they represent a potential dilution of a company’s stock if the holder eventually decides to exercise their right to convert the securities. This can affect the company’s market capitalization and share value. For investors, these securities offer the opportunity to benefit from potential upside in the company’s stock price without immediately committing to ownership. Unexercised convertible securities can be seen as a form of embedded option, providing both flexibility and potential reward for the holder.
For businesses, understanding the impact of unexercised convertible securities is critical when assessing potential dilution and the future distribution of ownership among shareholders.
Understanding unexercised convertible securities through an example
Imagine a company, XYZ Corp., issues convertible bonds with a $100 face value, convertible into 10 shares of common stock at a conversion price of $10 per share. If XYZ Corp.'s stock is trading at $8 per share, the bondholder might choose not to convert the bond because it would be less valuable than holding the bond itself. In this case, the bond remains "unexercised." However, if XYZ Corp.'s stock price rises above $10 per share, the bondholder may decide to exercise the conversion option, exchanging the bond for 10 shares of stock.
In another example, a startup issues convertible preferred stock to investors, allowing them to convert their preferred shares into common shares at a later date. If the stock price remains low, investors might hold on to their preferred shares, keeping them unexercised until market conditions are more favorable.
An example of an "unexercised convertible securities" clause
Here’s how a clause like this might appear in a contract:
“The Holder of Convertible Securities may exercise the conversion option at any time before the expiration date, subject to the conversion price and the terms outlined in this Agreement. Any Convertible Securities that remain unexercised at the expiration date will be subject to the applicable terms for redemption or maturity as specified in the Agreement.”
Conclusion
Unexercised convertible securities are financial instruments that give holders the option to convert them into common shares at a set price, but the conversion has not yet occurred. These securities are important because they represent potential future dilution of a company’s shares and can be exercised depending on favorable market conditions. For businesses, understanding the impact of unexercised convertible securities is crucial for managing shareholder equity and anticipating potential changes in ownership structure. For investors, these securities provide flexibility and the potential for future gains without immediate stock ownership.
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.