Death spiral financing

Death spiral financing is a label, not a legal category. It describes a convertible security whose conversion price is set by formula against a falling market price with no floor, so that every fall in the share price increases the number of shares issued, and every new share issued adds to the supply pressing on the price. The term describes an outcome, not an instrument.

Key takeaways

• The outcome comes from missing terms, not the instrument. Convertible securities priced against the market are ordinary and lawful. The spiral needs a specific combination of absences.
• Four features produce it. A floating conversion price with no floor, no ownership blocker, a pricing rule that selects the lowest recent day, and a holder free to sell into each conversion.
• The legal history is real and still open. The SEC pursued funders as unregistered dealers under Section 15(a)(1); the Eleventh Circuit affirmed in 2024, the SEC dismissed several actions in May 2025, and the Second Circuit's June 2025 Xeriant decision is under a pending certiorari petition (No. 25-531, docketed 29 October 2025).
• The failure is diagnosable before signing. Floor, blocker, averaging window and exchange cap are four terms an issuer can check in ten minutes.

Where the term came from

The phrase entered the market in the late 1990s to describe floorless convertible preferred stock and debentures sold to small listed companies, then often called toxic convertibles. Journalists coined it; regulators have never adopted it as a defined term. That matters, because a label with no definition gets applied loosely, and an issuer told a financing is a death spiral rarely gets a straight answer about which feature makes it one.

The honest formulation is narrower. A financing produces a spiral when its own arithmetic converts price weakness into share supply, and that supply into further weakness. A discount, a convertible or a private placement does not cause that on its own.

The mechanism, step by step

1. The instrument prices off the market

   Conversion is set at a discount to a recent volume weighted average price, not at a number fixed at closing.

2. The share price falls for ordinary reasons

   A missed milestone, a sector move, a thin quarter. Nothing improper is needed.

3. The lower price produces more shares

   With no floor, the same principal converts into more shares each time the reference price falls.

4. Those shares are sold into a thin market

   The holder monetises by selling. In a stock with modest volume, the sales themselves move the price.

5. The next conversion prices off the lower price

   The formula rewards the fall it helped cause, and the loop repeats until the principal or the float is exhausted.

The four features, and their opposites

What the regulatory record actually says

The most significant legal attack on this corner of the market was not about the instrument. It was about registration status. The SEC brought civil actions alleging that funders who repeatedly bought convertible notes from microcap issuers, converted at a discount and sold the resulting shares were acting as dealers, and so had to register under Section 15(a)(1) of the Securities Exchange Act. The Eleventh Circuit accepted that theory in Almagarby in February 2024 and again in Keener in May 2024.

The position then moved twice. In May 2025 the SEC dismissed with prejudice several civil actions whose sole claim was unregistered dealer activity, and sought dismissal of the dealer claim in another; Commissioner Crenshaw published a statement objecting. In June 2025 the Second Circuit decided Xeriant, Inc. v. Auctus Fund LLC. It is worth stating what that court actually held rather than the shorthand it is usually given: the issuer could not rescind the note under Section 29(b) of the Exchange Act because the agreement was capable of being performed lawfully and did not require the lender to act as a dealer, and enforcement of the Section 15(a) registration requirement rests with the Commission rather than with a private counterparty. The practical inference an issuer should draw is narrower than “lenders are not dealers”: it is that the dealer-registration argument is unlikely to unwind a note the issuer signed.

And it is not final. A petition for certiorari was docketed at the Supreme Court on 29 October 2025 as Xeriant, Inc. v. Auctus Fund, LLC, No. 25-531, on the question whether a party can contract to purchase a convertible note without violating Section 15(a) where it has already attained unregistered dealer status. The petition was still pending when this page was last reviewed. Anyone relying on the Second Circuit's reasoning should check the docket rather than a 2025 client alert.

Two conclusions follow. The dealer theory is no longer a reliable shield against a structure an issuer regrets signing. And the other legal frames have not moved: Section 5 registration, the conditions in Rule 144 and in particular Rule 144(i) for former shell companies, and the rules on short selling around offerings all continue to apply.

What a soundly structured financing looks like

A market-referenced financing that bounds the maximum share count at signing is identifiable on the face of the term sheet. It carries a hard floor and an ownership blocker. Its pricing window averages rather than selecting the worst day. It stops at the exchange capacity threshold instead of requiring the issuer to breach a listing rule. And it is sized against actual traded volume, because a facility larger than the float can absorb is a problem however it is drafted.

None of that makes a financing cheap or harmless for existing shareholders: every conversion dilutes, and the worked arithmetic shows how much. It makes the worst case knowable in advance, which is the only honest standard available. The instruments are on the instruments hub, the alternatives that avoid conversion pricing on the registered direct offering page, and the exchange limits on the markets hub. If a term sheet with a reset in it is already in front of you, send the floor, the blocker and the cap.

Related reading

• All insights
• Rule 105 and the trading window before pricing
• Capital-raising routes
• Check whether you qualify

Primary sources

• Eleventh Circuit — SEC v. Almagarby, opinion
• SEC — Crenshaw statement on ending dealer lawsuits, 22 May 2025
• eCFR — Rule 105 of Regulation M
• Second Circuit — Xeriant, Inc. v. Auctus Fund LLC, No. 24-682 (25 June 2025)
• Supreme Court — petition for certiorari, Xeriant v. Auctus, No. 25-531 (29 October 2025)

Death spiral financing: frequently asked questions

Is death spiral financing illegal?

The structure itself is not a prohibited instrument. Convertible securities priced against the market are lawful and are used routinely. What has been litigated is conduct around them: whether a funder that repeatedly bought convertible notes, converted at a discount and sold the resulting shares was acting as an unregistered dealer, and whether the resale of those shares was a registered or exempt transaction. Those are separate legal questions from whether the instrument may exist.

What is a floorless convertible?

A convertible security whose conversion price is a formula applied to a recent market price, with no minimum. Because there is no minimum, there is no maximum number of shares. A holder converting at a price that falls by half receives twice as many shares for the same principal, and the total issuable is unknown until the last conversion is made. That single missing term is what separates a normal convertible from the structure the term describes.

Did the SEC sue convertible note funders?

Yes, and the position is still moving. The SEC brought civil actions alleging that funders who bought convertible notes from microcap issuers, converted them and sold the shares acted as unregistered dealers under Section 15(a)(1) of the Exchange Act. The Eleventh Circuit affirmed that theory in the Almagarby and Keener appeals in 2024. In May 2025 the SEC dismissed with prejudice several actions whose only claim was unregistered dealer activity. In June 2025 the Second Circuit in Xeriant v. Auctus held that the issuer could not rescind its note under Section 29(b) because the contract could be performed lawfully, and that Section 15(a) enforcement rests with the Commission rather than a private party. A petition for certiorari in that case was docketed at the Supreme Court on 29 October 2025 as No. 25-531 and had not been decided when this page was last reviewed.

How can an issuer tell a sound structure from a dangerous one?

Read for four terms before reading the price. Is there a hard conversion floor, so the maximum share issuance is knowable on day one? Is there an ownership blocker limiting how much stock any holder can take at once? Does the pricing window use an average rather than the lowest single day? And does issuance stop at the exchange threshold until shareholders approve more? A structure with all four caps the maximum share issuance at signing, which is the runaway the term describes. It does not make the financing cheap, and it does not protect against a price that falls for its own reasons.