Converting notes with discounts and caps

Convertible notes have become dramatically more common in the last 10 years, to the point that they’re used even when they’re not particularly necessary or helpful.

Regardless, if you have notes with a discount and a cap, it’s difficult for some people to figure out how that fits into a transaction. One model is presented here. You can use this to see the effect of different caps in the note to the post-money cap table, and you can experiment with different discounts as well.

This is one tool for calculating the proper conversion of these notes. Not all deals are in fact the same, but this is the common expectation of most founders.

Some investors will treat equity from convertible notes differently, taking the [reasonable] position that new money invested at a current pre-money valuation should give them the mathematical outcome they’d expect (i.e., $500k at $2m pre-money means 25% post). I’ve previously addressed this question in “Are convertible notes pre-money?” The argument is that if convertible notes get more shares because of caps and discounts, that dilution should be explicit because it should, or will be, borne wholly by the pre-money holders. It’s not without its supporters, and there is some logic to it (this potential problem is another reason that using too many notes for too long on different terms complicates deals more than founders realize).