Note conversion math

When a note converts, you compute two prices — discount and cap — and the investor takes the lower one (more shares). Accrued interest usually increases the dollars that convert at that price.

Walking through a conversion

Company facts before Series A:

• Founders + employees in the note's FD definition: 8,000,000 shares
• Note: $500,000 principal, 6% simple interest, 20% discount, $8,000,000 cap
• Age at conversion: 18 months = 1.5 years
• Series A: $4,000,000 at $16,000,000 pre-money
• Pre-money share count for the Series A price (matching the note's FD base here): 8,000,000

Real rounds also shuffle the pool. Ignore that here so the note math stays visible.

1. Accrued conversion amount

Interest            = $500,000 × 0.06 × 1.5 = $45,000
Conversion amount   = $500,000 + $45,000    = $545,000

2. Series A price

Price_A = $16,000,000 / 8,000,000 = $2.00 / share

3. Discount price

Price_discount = $2.00 × (1 − 0.20) = $1.60

4. Cap price

Price_cap = $8,000,000 / 8,000,000 = $1.00 / share

5. Conversion price and shares

Conversion price = min($1.60, $1.00) = $1.00
Note shares      = $545,000 / $1.00  = 545,000

6. Series A new shares and ownership

Series A shares = $4,000,000 / $2.00 = 2,000,000
Total shares    ≈ 8,000,000 + 545,000 + 2,000,000 = 10,545,000
Note holder     ≈ 545,000 / 10,545,000 ≈ 5.2%
Series A        ≈ 19.0%
Prior holders   ≈ 75.9%

Without interest the note would have bought 500,000 shares (~4.7%). The $45,000 of interest bought 45,000 extra shares.

If the cap had implied $1.00 and you only had the 20% discount, you would have converted at $1.60. The cap is what made this an early-bird price.

Phantom liquidation preference

When a note converts at a discount or cap into preferred whose 1× liquidation preference equals the round's original issue price, early money can receive a preference larger than cash invested.

Common mistakes

• Picking the higher price. Better-of means the lower price for the investor.
• Dropping interest. 45,000 shares here; more if the note is older or larger.
• Ignoring preference mechanics on discounted conversions into 1× preferred.

Check yourself

Round price $2.00, 20% discount, cap price $1.00. What does the note convert at?

$1.00 — the lower of $1.60 and $1.00.

Why did $45,000 of interest matter?

It bought 45,000 extra shares at the $1.00 conversion price.

Key takeaways

• Convert at the better (lower) of discount price and cap price.
• Interest usually increases the conversion amount and the share count.
• Watch liquidation preference when cheap conversions become preferred.

Further learning

Next, note maturity — what happens if the priced round does not arrive.