On Monday, Mullen Automotive (NASDAQ:MULN) announced it had reached a deal with its creditors to amend its Series D Preferred Stock Agreement. Under the new terms, the EV startup would provide its backers 296.9 million of common stock and pre-funded warrants for a $45 million capital injection. This replaces an agreement that offers Series D Preferred Stock and regular warrants for the money.

Together, this means shareholders face immediate dilution. Once the funding deal is complete, Mullen’s share count will rise from 172.5 million — based on its May 10-Q filing — to approximately 548 million if investors include a separate $20 million deal from last week. That math works out to:

• 172.5 million shares from its May 12, 2023 10-Q filing
• 19.5 million shares of common stock for Acuitas Capital (June 5)
• Pre-funded warrants exercisable for 8 million shares of common stock for Acuitas (June 5)
• Warrants exercisable for 51 million shares of common stock for Acuitas (June 5)
• 54.7 million shares of common stock (June 12)
• Pre-funded warrants exercisable for 49.5 million shares of common stock (June 12)
• Warrants exercisable for 192.7 million shares of common stock (June 12)

Put another way, Mullen’s shareholders have seen shares outstanding rise 3.2X in less than five weeks.

The firm followed up on Tuesday with a plan to increase its 2022 Equity Incentive Stock Plan by 52 million shares at its August annual meeting. It will also attempt to approve up to a 1-for-10 reverse stock split and move its charter to Maryland to give the board “the power to amend the charter of the corporation, without a stockholder vote, to increase or decrease the aggregate number of authorized shares.”

That bodes poorly for those who remain invested in MULN stock. The company only has until September 2023 to regain compliance with the Nasdaq’s required minimum $1 bid price, and these significant dilutions (and the potential future ability to create more) suggest the company has little chance of making that happen.

Mullen was always running on borrowed time. And the realities of its “death spiral financing” are finally catching up.

Mullen Stock: Selling $1 Bills for 43 Cents

Mullen’s June 12 financing deal highlights its reliance on a toxic method of fundraising — the use of convertible instruments to raise cash. I outline here how this form of financing creates a “death spiral” since these dilutive issuances create a negative feedback loop for share prices.

For every cent a stock falls below the exercise price, the amount of dilution rises exponentially. At 50 cents, Mullen would need to issue 550 million new shares ($275 million divided by a 50-cent conversion price). At 25 cents, that comes to 1.1 billion shares, and so on. These new shares then depress prices even further. Investors know that millions of new shares are coming onto the market, so they revalue existing shares accordingly. The incentives are so perverse that even creditors might become tempted to short shares of companies they own to protect from downside risk.

The EV firm’s most recent deal accelerates this trend. As late as last week, Mullen raised $20 million in exchange for 77.6 million new stock and equivalents. That was 25.8 cents of cash raised for every Mullen share issued.

The latest deal now requires the firm to hand over 296.9 million shares for a $45 million cash injection, a far worse valuation. Mullen’s stock now only generates 15.2 cents per share in this latest deal.

From a cynical perspective, that means Mullen is “selling” $1 bills for 43 cents. Every 15.2 cents of stock and warrants bought by creditors can get immediately turned around for Mullen’s current market value of 35 cents, or a 0.43-to-1 profit ratio. The dilution caused by these issuances will only worsen future funding rounds.

When Will Mullen Reverse Split Its Shares?

Mullen must trade above $1 for at least 10 consecutive days by Sept. 5, 2023 to regain compliance with the Nasdaq Exchange’s minimum bid price rules. A brief period of above-$1 prices last month has proved insufficient to remove Mullen from the Nasdaq’s list of non-compliant companies.

That means Mullen’s management must reverse-split shares again to avoid a delisting.

In an alternate reality, they would have already performed a reverse split. Mullen’s stock currently trades at 35 cents, so dividing shares outstanding by 10 would theoretically send prices to $3.50 — well above the $1 minimum bid price. (Nasdaq rules prohibit cumulative reverse splits of more than 1-for-250 over two years, and Mullen’s recent 1-for-25 split means it can only reverse split another 1-for-10).

But in practice, the company is limited by Delaware’s corporate governance rules. The state typically requires the majority of outstanding shares to approve a reverse split and Mullen’s meme status makes it difficult to reach a quorum. That means Mullen must wait until its annual meeting to approve conversion to a Maryland corporation if it plans to enact a split unilaterally.

By then, it could be too late. The company already faces delisting from the Russell 3000 and Russell 2000 indices later this month, and the selling pressure by funds that hold Mullen could send shares to the point where a 1-for-10 reverse split won’t achieve a $1 share price.

Mullen’s lack of meaningful revenue will also add to the concern. Though the firm expects some cash inflow from a 1,000-vehicle deal in August, the funding will likely prove insufficient to balance its budget.

What Should Investors Do?

Profit-seeking speculators can still gain through buying puts on the company’s stock. 50-cent puts expiring next month are available for as little as 23 cents, meaning that investors will profit if the stock drops below 27 cents.

Even longer-dated puts have a high chance of paying out. Mullen’s 50-cent puts expiring in October sell for 35 cents, putting their breakeven price at 15 cents. Mullen’s stock could easily hit this level if the firm fails to meet Nasdaq listing rules.

Of course, investors should be wary of betting too much on Mullen’s demise. Its meme potential means even the slightest bit of positive news from its upcoming Randy Marion deliveries this August could send shares skyrocketing. The high implied volatility of Mullen’s shares also means bearish options buyers face exceptionally high theta decay. But if you still hold onto MULN stock, it’s probably best to sell while you still can. According to data from Fintel.io, retail investors have already cut their positions by a third since late May. And you don’t want to be the one holding the bag in any firm going through a financing death spiral.

As of this writing, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.