How a convertible note converts
A convertible note is a loan that turns into equity at the next priced round. Unlike a SAFE, it accrues interest, and the interest converts too, so the noteholder converts principal plus interest. Interest on startup notes is almost always simple, not compounding:
- Amount converting = principal × (1 + annual rate × months ÷ 12)
- Cap price = valuation cap ÷ fully diluted shares before the round
- Discount price = round price × (1 − discount)
- Conversion price = the lowest of cap price, discount price and round price
- Shares issued = amount converting ÷ conversion price
The effective pre-money above is the valuation the noteholder actually bought in at: the conversion price times the pre-round share count. When the cap wins, it equals the cap; when the discount wins, it is the round’s pre-money less the discount.
A worked example
A $500,000 note at 6% converts 18 months later. Interest is $500,000 × 6% × 1.5 = $45,000, so $545,000 converts. The Series A is priced at $15 million pre-money on 10,000,000 shares, which is $1.50 a share. The 20% discount gives $1.20; the $8 million cap gives $0.80. The cap wins, so the noteholder receives 681,250 shares, about 5.4% of the company after the $3 million round.
What varies from note to note
Notes are less standardised than SAFEs. Some caps are measured on a different share count, some notes exclude interest from conversion, and some include the new option pool in the cap calculation. This calculator uses the common simple form and issues the note shares on top of the pre-money, so the new investors share the note’s dilution. Investors often ask for the note to be counted inside the pre-money instead, which puts all of that dilution on existing holders. Check your note’s definitions and the term sheet. For the trade-offs between the instruments, read SAFE vs. convertible note. If you raised on a SAFE instead, use the SAFE calculator.