Legal Definitions - conversion ratio

The conversion ratio is a critical figure that specifies how many shares of a company's common stock an investor will receive when they choose to exchange a convertible security for those shares. Essentially, it establishes the exchange rate between a convertible investment (such as a convertible bond or convertible preferred stock) and the company's regular common stock. This ratio can be stated as a fixed number of common shares per convertible security, or it can be calculated by dividing the face value of the convertible security by a predetermined conversion price.

• Example 1: Convertible Corporate Bonds

  A renewable energy company issues convertible bonds, each with a face value of $1,000. The terms state that each $1,000 bond can be converted into 25 shares of the company's common stock. In this scenario, the conversion ratio is 25 shares per bond.

  This example illustrates the conversion ratio as the direct number of common shares an investor receives for each convertible bond they hold and choose to convert.

• Example 2: Convertible Preferred Stock

  A well-established retail chain offers convertible preferred stock to investors. The agreement specifies that each share of preferred stock can be exchanged for 3 shares of the company's common stock. Here, the conversion ratio is 3 common shares per preferred share.

  This demonstrates how the conversion ratio dictates the exchange rate when an investor converts a different class of equity (preferred stock) into common stock, providing a clear understanding of the value they receive.

• Example 3: Startup Convertible Notes

  An early-stage software startup raises initial funding through convertible notes. The terms of these notes state that for every $500 of the note's principal amount, the investor can convert it into 10 shares of common stock once the company completes its next round of equity financing. In this case, the conversion ratio is 10 shares for every $500 of the note's value.

  This example shows the conversion ratio applied to a debt instrument (a convertible note) where the ratio is tied to a specific monetary value of the security, defining how much equity an investor will gain upon conversion.