How it's calculated
A convertible note is a loan that turns into shares at the next priced round. Interest is usually not paid in cash: it accrues, typically as simple interest, and converts into shares along with the principal. MIT's Martin Trust Center describes the usual terms: a discount, often around 20%, on the price new investors pay; a valuation cap, "the maximum valuation allowed for the startup for the purpose of conversion"; interest of a few percent a year; and a maturity often 12 to 24 months out.MIT Martin Trust Center for Entrepreneurship
When a note has both a cap and a discount, the investor converts at whichever gives the lower price and so more shares, the same rule YC uses for SAFEs.Y Combinator
The formula
- Accrued interest = principal × annual rate × months ÷ 12
- Amount converting = principal + accrued interest
- Round price = pre-money valuation ÷ fully diluted shares before the round
- Cap price = valuation cap ÷ the same shares; discount price = round price × (1 − discount)
- Conversion price = the lowest of the three; shares = amount converting ÷ conversion price
Worked example
A $500,000 note at 6% converts after 18 months, so $45,000 of interest has accrued and $545,000 converts. In a round at a $12 million pre-money on 10 million shares ($1.20 a share), the $8 million cap gives $0.80 and the 20% discount $0.96, so the cap applies: the holder receives 681,250 shares, or 5.168% after the round.
| Line | Amount |
|---|---|
| Principal | $500,000 |
| Interest: 6% simple for 18 months | $45,000 |
| Amount converting | $545,000 |
| Round price per share | $1.20 |
| Discounted price (20% off) | $0.96 |
| Cap price ($8,000,000 ÷ 10,000,000 shares) | $0.80 |
| Conversion price (lowest) | $0.80 |
| Shares issued to the note holder | 681,250 |
If the round were priced at a $9 million pre-money instead, the discount would give the lower price: $0.72 per share.
Assumptions and limitations
- Pre-money cap on pre-money shares. Notes differ on whether the cap applies to pre-money or post-money capitalisation and whether the option pool counts; check your note's definitions.
- Simple interest, accrued to the round date and converted with the principal.
- One note. For several notes or SAFEs converting together, convert each and add the shares; use the SAFE calculator for post-money SAFEs.