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05/23/23 4:58 PM
05/23/23 5:12 PM
How in the world do these toxic lenders make money on OTC revocations then
How Dilution Funders Operate
Everyone interested in penny stocks, either as an investor or an observer, knows that nearly all microcap issuers are in perpetual need of financing. Reputable banks are usually uninterested in lending, and government entities like the Small Business Association are slow to process applications. In the end, a great many small public companies turn to what are sometimes called toxic or dilution funders to meet their needs.
These funders operate by purchasing convertible promissory notes from their client companies using documents drafted by their sometimes complicit lawyers. Typically, the notes can be converted at any time into the companies’ common stock. Worse yet, when the lender converts, he receives an amount of stock fixed at a pre-negotiated discount to the market that can be as large as 70 percent. The notes often contain default and penalty provisions providing lenders with the ability to receive even more shares if the stock price drops below a certain level or upon the occurrence of certain events, such as non-compliance with SEC reporting requirements or other obligations.
As the lender sells the shares resulting from those conversions, stock price declines, often dramatically. Generally, he doesn’t convert the entire note at one time, but in several tranches. Since the conversion ratio is pegged to the security’s recent average bid price, every time he converts, he gets more stock than the time before. That is why these kinds of convertible notes are called “floorless” convertibles: there is no floor supporting a minimum bid price. Another more graphic name for them is “death spiral convertibles.”
The damage the toxic funders can do, first to the company itself, by forcing dilution that’s sometimes so catastrophic management has no choice but to do to a very large reverse split. As the dilution continues quarter over quarter, a second and then a third split may be required. Investors lose faith in the company, and everyone but the toxic lender loses money.
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