What happened

Hydrogen fuel cell truck making start-up Nikola (NKLA -2.33%) announced plans this morning to raise cash by selling up to $125 million in senior convertible notes (i.e., debt that is convertible into common stock).

Nikola stock tumbled 4.8% through 11 a.m. ET on the news.

So what

The company laid out its intentions in an 8-K filing with the Securities and Exchange Commission. Nikola plans to sell $50 million worth of convertible notes today, but will collect only $46.5 million of that after expenses. It may or may not raise an additional $75 million (before fees) over the course of the next year by selling the balance of the $125 million worth of notes. Nikola notes that this sale is being made directly to a group of (unidentified) buyers, without underwriters or other intermediaries (which raises the question of where exactly $3.5 million from the initial offering is going).  

Nikola will pay a favorable interest rate (at least, favorable in the current high interest rate environment) of only 5% on the notes. However, in the event of any kind of default on the notes (such as Nikola declaring bankruptcy), this interest rate will shoot up to 12.5%. That's probably not too important, however, because as is standard in these types of agreements the notes will also "become automatically due and payable" if such a default happens.

Now what

On the plus side, Nikola is getting a pretty decent interest rate on this deal, and extra cash to keep its operations afloat in the near term. On the minus side, however, taking on even the initial $50 million in new debt will tip Nikola's balance sheet into the red, giving the company more debt than cash on balance.

For a company that has never generated positive free cash flow to fund its operations, and that, indeed, is burning more and more cash with each passing year -- more than $725 million in negative free cash flow over the past 12 months -- taking on new debt may be a necessary evil. It's not a positive development for shareholders, however, and this, in a nutshell, is why Nikola stock is sinking today.