What happened

Shares of Verastem (NASDAQ:VSTM) are down 10.4% at 12:43 p.m. because the company is selling $150 million worth of convertible notes due in 2048 with an interest rate of 5%. That might seem like a low interest rate to be paying for such a long term, but the note holders can convert the notes into 139.5771 shares for every $1,000 principal amount of the notes they own.

Doing the math, the note holders are essentially buying the equivalent of shares at $7.16 each -- a 15% premium to yesterday's close -- and getting paid 5% per year to wait until the shares go up to $7.16 and beyond. If shares get to or above 130% of the conversion price for a period of time and other conditions are satisfied, Verastem can force note holders to convert their notes into shares if it wants to.

Magnifying glass and pen on a balance sheet.

Image source: Getty Images.

So what

Whether a company sells shares directly in a secondary offering or sells convertible notes that will likely eventually be converted into shares, current shareholders are diluted. If all the notes are converted, they'll add about 21 million additional shares to the approximately 61 million outstanding at the end of the second quarter.

Slicing the company into more shares means current shareholders will own a smaller piece of the pie. Of course, the hope is that the pie will eventually be much larger, but the fact that Verastem is raising capital implies that it could take awhile.

Now what

Adding the $145.4 million it'll get from selling the convertible notes, after transaction fees and expenses, to the $168.7 million Verastem had in the bank at the end of the second quarter, the company looks to be in good shape financially to launch Copiktra, a treatment for chronic lymphocytic leukemia/small lymphocytic lymphoma and follicular lymphoma, which was approved by the FDA a couple of weeks ago.

Given the company's desire for additional capital, cautious investors should probably stay on the sidelines until it's clear what the launch trajectory for Copiktra looks like.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.