Convertible Debenture Financing

Convertible Debentures are, in most cases, the kiss of death when it comes to financing for a new company seeking to raise capital. It is a financial structure that can destroy a company if the Officers and Directors do not pay attention to the terms and conditions of the financing. So, the devil is in the details so to speak. Many of the hedge funds specialize in this type of structure. They take the amount of money you are trying to raise and turn it into a convertible loan with an interest rate from anywhere from 8% to 12%. They then can convert the loan into shares of stock at a discount to the bid price. Sounds pretty good so far, doesn’t it. Here is the downside. Company CEO’s assume that as the price of the stock goes up the hedge fund will make money on the increase in the price of the stock from the preset strike or price they are paying, right? Well, yes and no. The hedge fund also puts in a protective devise that allows them to “adjust” the strike price of the stock if it takes a dive. So, what’s wrong with that you say? Wells let’s look at two very different scenario’s and how it could effect your company.

Company “A” has just received $10 million on a Convertible Debenture. The loan can be converted into shares at $1.00 per share (the “Strike Price”). Company A is the rage and the stock starts to take off and by the time the hedge fund gets their shares registered the stock is now trading at $3 per share. The hedge fund starts liquidating their shares @ $1.00 a share but there is enough interest in the company that the shares are absorbed in the marketplace and the shares continue to trade between $2 and $3 a share after the hedge fund has sold off all of their shares. The Company has issued the hedge fund its 10 million shares and everyone is happy.

Company “B” has just received a similar $10 million funding on a Convertible Debenture. The loan can also be converted into shares at $1.00 per share. Company B business plan is not going as scheduled and investors are starting to sell off the stock. The stock price falls to $.80 a share. The hedge fund gets their shares registered and they start selling the stock short until all of their shares are liquidated. There is no support for the stock so the stock price continues to drop until it reaches $.01 a share. The hedge fund now comes to Company B and converts all of their shares at less than a penny. The Company has to issue the hedge fund 1 BILLION shares because their stock dropped to one penny. The hedge fund doesn’t care because they were selling shares all the way down as the stock dropped. The hedge fund is constantly hitting the bid. Now I know you are going to say, “But selling an OTCBB stock short is illegal” and I will agree. But that is how these guys make their money.

The actual definition of a hedge fund is as follows:

“A fund, usually used by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to mutual funds, including selling short, leverage, program trading, swaps, arbitrage, and derivatives. Hedge funds are exempt from many of the rules and regulations governing other mutual funds, which allows them to accomplish aggressive investing goals.”

The bottom line is this. If the hedge fund can make more money off of you if the stock goes up and has momentum, they will. If they think they can make more money by shorting your stock, they will. So be very careful who you get in bed with. It can make or break your company.

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