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Death Spiral Financing

Death spiral financing refers to a risky type of financing arrangement where a company issues convertible debt or convertible preferred stock, allowing the investor to convert their holdings into common stock at a discounted price. As the investor converts and sells shares, it can lead to a sharp decline in the stock price, creating a “death spiral” effect where more shares are issued, further diluting the stock and driving the price down.

Example

A struggling company issues convertible debt to raise funds, but as investors convert the debt into shares and sell them, the stock price plummets, leading to significant dilution and further declines in share value.

Key points

• Death spiral financing involves convertible debt or preferred stock that can be converted into common shares at a discount.

• It can lead to a sharp decline in the stock price due to dilution and selling pressure.

• This type of financing is considered risky and can hurt existing shareholders.

Quick Answers to Curious Questions

It leads to significant stock dilution as investors convert their holdings into common shares, driving down the stock price and creating a negative cycle.

Existing shareholders suffer from dilution, as more shares are issued, and the stock price declines, reducing the value of their holdings.

Companies may consider traditional debt financing or issuing new equity to avoid the dilution and stock price pressure caused by death spiral financing.