Compare a convertible note's cap and discount before the next round

A note with a valuation cap and a discount can convert differently as the next round's price changes. Extract the conversion event, amount converting, capitalization definition and price-selection rule from the actual document. Ask counsel to resolve them before comparing financing proposals. A cap amount alone cannot tell management how many shares will be issued.

DLA Piper explains that caps and discounts can determine different conversion prices and that the negotiated capitalization definition affects the cap calculation. It also notes that accrued interest may form part of the conversion amount. Those features depend on the instrument; do not apply one note's spreadsheet formula to every financing agreement.

Assume a hypothetical $400,000 note accrues 12% simple annual interest for exactly one year. Its terms convert principal and accrued interest together, producing $448,000. Assume a $6 million cap divided by four million contract-defined share equivalents, a 20% discount to the new round price, and conversion at the lower resulting price. Exclude other convertibles and pool changes.

The cap price is $1.50. At a $2 new-round price, the discounted price is $1.60, so the assumed rule selects $1.50. The note receives approximately 298,667 shares. If the round price is $1.50 instead, the discounted price is $1.20 and controls, producing approximately 373,333 shares. Actual issuance needs the agreement's rounding convention.

The two prices are equal when 80% of the round price equals $1.50. That occurs at $1.875. Above that point, the cap controls under these assumptions; below it, the discount controls. The result is a feature of this specified note, not a valuation target or a recommendation for pricing the company's next round.

One further month of simple interest in this example adds $4,000 to the converting amount. At an unchanged $1.50 conversion price, that creates approximately 2,667 additional shares. Use the actual accrual dates and day-count terms in a live model. A delayed closing can change the share issuance even if the headline round valuation stays constant.

Check whether interest converts on the same terms as principal. If the assumed $48,000 interest were instead payable in cash, principal alone would create approximately 266,667 shares at $1.50, and the company would need cash for the interest. That is a different liquidity and dilution outcome requiring explicit contractual support.

Place the calculated note shares beside existing shares, new-money shares and any agreed pool increase. Recalculate the percentage denominator after all relevant events. A note's share count does not by itself establish its final ownership percentage, particularly when several instruments convert on different terms.

Keep historical note funding out of the new cash receipt line. Conversion changes the instrument and capitalization; the principal was funded earlier. Include only actual new subscriptions and any cash settlement of interest or other amounts in the closing cash forecast.

Have counsel confirm whether the proposed financing triggers conversion and which security the note receives. Liquidation rights or other terms may differ from those attached to the new-money shares. A model that gets the share count right can still omit a material economic difference between classes.

Show the proposed round price, switching point, delayed-closing case and resulting ownership together. Identify which change matters most: price, capitalization denominator, interest treatment or timing. This lets management discuss a specific economic consequence with advisers and investors.

Reconcile the approved conversion to the executed note, amendments and final financing documents. Preserve the calculation and assumptions for the closing team. The company's decision should rest on a reviewed conversion model, while legal rights and accounting classification remain assigned to the appropriate professionals.