Convertible Note Calculator

A convertible note is a loan expected to be repaid in shares rather than cash. It exists to postpone the hardest question in early-stage financing, what the company is worth, until a priced round establishes a share price. Two terms decide how the investor is compensated for waiting. The valuation cap fixes a maximum valuation for conversion purposes, so the cap divided by shares outstanding gives one candidate price per share. The discount reduces the round price by a set percentage, typically 15 to 25 percent, giving a second candidate. The note converts at the lower of the two, which is why this calculator reports which of the two mechanisms won. Because it is debt, the note also carries an interest rate, usually 2 to 8 percent and commonly around 5, which accrues but is rarely paid in cash. It is added to principal and converts alongside it, so 500,000 dollars at 5 percent over 18 months converts as 537,500 dollars. Terms typically run 12 to 24 months, and conversion is triggered by a qualified financing, often defined as the company raising at least one million dollars of new equity. Two caveats dominate in practice. Whether the cap is stated pre-money or post-money changes the resulting ownership materially and must be specified in the document. And stacked notes with low caps compound: several small notes can convert into far more of the company than founders modelled, particularly when the priced round lands well above the caps.

Convertible securities long predate venture capital. Convertible bonds giving lenders the right to exchange debt for equity were used by American railroad companies in the nineteenth century, and the structure has always served the same purpose, letting a lender accept a low coupon in exchange for participation in the upside. Startups adopted the instrument for seed financing because the alternative, negotiating a priced equity round, required agreeing a valuation for a company with little or no revenue and paying substantial legal fees to paper it. Use of notes for seed rounds became common through the 1990s and expanded sharply in the mid-2000s as seed investing professionalised and the cost of starting a software company fell. Valuation caps, which were not universal at first, became standard after investors found that uncapped notes could convert at valuations high enough to leave them with negligible ownership despite having taken the earliest risk. Standardised paperwork followed from law firms and accelerators, and Y Combinator's SAFE, released in 2013 and drafted principally by Carolynn Levy, removed the interest rate and maturity date entirely. SAFEs have since displaced convertible notes for much United States pre-seed and seed activity, though notes remain common for bridge financings and in many markets outside the United States.