Convertible note
A convertible note is a loan that turns into shares instead of being repaid. It has the three things a SAFE does not: a principal, an interest rate, and a maturity date. Where the interest accrues rather than being paid out in cash, it is added to the amount that converts, so it is paid in equity.
The cap table we will use
| Holder | Shares | Ownership |
|---|---|---|
| Founders | 8,100,000 | 90.0% |
| Option pool | 900,000 | 10.0% |
| Total | 9,000,000 | 100.0% |
An investor lends $625,000 at 8% simple interest, with a $7,000,000 cap, and the round happens eighteen months later.
Step one: what actually converts
$625,000 × 8% × 1.5 years = $75,000 of interest
$625,000 + $75,000 = $700,000 converting
Not $625,000. The number that converts is the principal plus everything that accrued while you were building.
Step two: the conversion
$700,000 ÷ $7,000,000 = 10.00%
9,000,000 ÷ 0.90 = 10,000,000 shares, of which the holder receives 1,000,000.
| Holder | Shares | Before | After |
|---|---|---|---|
| Founders | 8,100,000 | 90.0% | 81.0% |
| Option pool | 900,000 | 10.0% | 9.0% |
| Note holder | 1,000,000 | 10.0% | |
| Total | 9,000,000 → 10,000,000 | 100.0% | 100.0% |
What the interest cost
Had only the principal converted, the holder would have taken $625,000 ÷ $7,000,000 = 8.93%.
With the interest, they take 10.00%.
1.07 points, on these numbers, for eighteen months at 8%. Longer to a round, or a higher rate, and the number grows. It is worth computing on your own note rather than carrying 1.07 around, because the term that drives it is time, and time is the variable you control least.
The maturity date
A note falls due. What happens at maturity is whatever the document says: repayment, extension, or conversion on stated terms, in whatever combination it sets out. A SAFE has no equivalent, which is why the maturity clause is the part of a note to read closely.
What to check in your own documents
- Simple or compound interest, and on what day count. The two produce different numbers on the same rate.
- The date interest starts running. Signing, funding and closing are not always the same day.
- The maturity date, and what the document says happens on it. That is the clause with the most consequence and the least attention.
- Whether the note also carries a discount, because that is a second candidate price alongside the cap.
Run it on your own numbers
Interest arithmetic is easy in isolation. A note accruing alongside two SAFEs at different caps, all landing in the same round, is not.
Promythia computes interest on a real day count and converts each instrument separately. Create a free account and enter your real note.
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