Let's talk a made up example:
Say the company owes someone $50,000.
The company, instead of paying with cash, pays with shares - "converts" that $50,000 to shares.
But, the shares to be paid have to be based on a value of those shares so they can calculate the number of shares to be given that will give that entity whom they owe a guarantee of getting $50,000 when that entity gets the chance to sell the shares (usually immediately upon conversion). Thus the shares are almost always valued at a discount to what the company's shares are selling at at the time, because when the shares get sold into the market, they will usually put downward pressure on the share price.
So, If the shares are selling in the open market at say .09, the company says we will give you 1,250,000 shares VALUED AT .04 (or conversion price of .04 because .04x1250000=$50000). The company has then paid what they owe (paid with shares) to the owed entity, and the owed entity can then go out to the open market and sell those shares however they want. If they dump them all at once, they could easily drive the price down to .04, but they are likely to be a bit more careful and sell in 3 or 4 chunks, to try to make a profit off of those shares in addition to getting what was owed to them. However, if the price gets close to the conversion price, they are likely to dump as fast as they can all the way down to the conversion price so that they are assured of getting at least what was owed to them.
And all along, the retail shareholders take the lumps as the entities get their monies.
