Nov 4, 2009
What is "optional" conversion and what is a "mandatory" or "automatic" conversion?
Convertible preferred stock, the type of preferred stock ordinarily issued in venture transactions, provides that the preferred stock is convertible into common stock in specified circumstances. First, each holder of preferred stock will have the right to convert its shares of preferred stock into common stock at any time, a so-called "optional conversion" feature. Second, the preferred stock will generally be subject to mandatory conversion into common stock, without any action on the part of the holder, upon the occurrence of certain events. The most common of these conversion events is the occurrence of an initial public offering of the company. Usually, a public offering will trigger a mandatory conversion only if the offering price per share and the aggregate size of the offering exceed specified thresholds. The preferred stock may also be automatically convertible into common stock upon the written election of the holders of a majority or specified supermajority of the preferred stock. Finally, if the terms of the preferred stock contain a "pay-to-play" provision, all or some portion of a preferred stockholder's shares may be converted if the stockholder fails to participate in the next round of financing at the level specified in the pay-to-play provision.
