investmentCan anyone please help me understand the following: I recently raised $20,000 as a convertible note with $2,500,000 cap and 25% discount.
I’m now raising another $100,000 round at $3,000,000 valuation.
What happens with the first convertible note? Does it convert at $100,000 valuation or at $3,000,000 valuation?
Is it the dollar amount raised that goes into formula for calculating conversion or the valuation of the new round?
Quoting FoundersClub:
Numerical Examples: $25k convertible note with $5M cap, 20% discount
Let’s do numerical example ignoring any accrued interest:
You invest $25k in a startup’s seed round using a convertible note with a $5M cap, 20% discount
If, at the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of $10M with a per share price of $5.00 IF we apply the discount, the price per share would be $4.00/share ($5.00 times (1 minus 20%)) IF we apply the cap, the price per share would be $2.50/share ($5.00 times ($5M cap divided by $10M pre-money valuation)) THUS the cap would apply and the note would convert at $2.50/share which gives 10,000 shares of Series A Preferred Stock ($25,000 divided by $2.50/share). On paper, your 10,000 shares at $5.00/share are worth $50,000 which is an unrealized return of 100%
If, at the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of $6M with a per share price of $5.00 IF we apply the discount, the price per share would be $4.00/share ($5.00 times (1 minus 20%)) IF we apply the cap, the price per share would be $4.1667/share ($5.00 times ($5M cap divided by $6M pre-money valuation)) THUS the discount would apply and the note would convert at $4.00/share which gives 6,250 shares of Series A Preferred Stock ($25,000 divided by $4.00/share). On paper, your 6,250 shares at $5.00/share are worth $31,250 which is an unrealized return of 25%
Assuming your $3,000,000 valuation is the standard pre-money valuation and you have X number of outstanding shares before the priced round.
The 3M raise values the share price at 3M/X dollar per share. 100k investment yields 0.1M/(3M/X) = 0.0333 * X shares.
For the convertible note, if it’s converted with the 25% discount, it will convert at 3M/X * 0.75 = 2.25/X dollar per share.
If it’s converted with the 2.5M pre-money valuation with the “post series A out standing shares” (this is the worse case scenario, read your contract carefully), it will convert at 2.5/(X+0.0333X) = 2.4194/X dollar per share, which is still higher than 2.25/X.
Therefore, the 25% discount will kick in for your case.
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