Understanding the Procedure of Converting Convertible Notes

Price per Share without Convertible Notes

When determining the price per share for Series A financing, it's relatively straightforward if there are no outstanding convertible notes or SAFEs (Simple Agreement for Future Equity). The price per share for the new investors is typically calculated as the pre-money valuation divided by the fully-diluted shares outstanding. Here's how it works:

Assumptions

• Agreed Upon Pre-Money Valuation: $8 million
• Agreed Upon Post-Money Valuation: $10 million
• Amount Being Invested by New Series A Investors: $2 million
• Shares Outstanding on a Fully-Diluted Basis, Pre-Investment: 1 million

Pre-Money Method

In the pre-money method, the pre-money valuation remains fixed. The conversion price for the notes or SAFEs is determined based on this valuation. Here are the details:

The pre-money method results in both Founders and Series A Investors being diluted by the shares issued upon conversion of the notes or SAFEs.

Price per Share with Convertible Notes

Calculating the price per share becomes more complex when there are convertible notes or SAFEs converting into equity. The key questions are whose ownership percentage is diluted, and by how much. There are three common methods to address this:

Percentage-Ownership Method

In this method, the investor's percentage ownership is fixed, and other variables are computed accordingly. Here's an example using the same assumptions:

The percentage-ownership method results in Founders bearing most of the dilution.

Dollars-Invested Method

This method aims for a compromise between the pre-money and percentage-ownership methods. The post-money valuation is fixed to include the agreed pre-money valuation, the new investors' investment, and the principal and accrued interest on the notes or SAFEs. Here's an example:

The dollars-invested method credits Founders for the principal and accrued interest on the notes or SAFEs but dilutes their ownership.

Conclusion

Calculating the price per share in a Series A financing with convertible notes can reopen discussions about the company's valuation. The chosen method determines how ownership percentages change. Each method has its pros and cons, and parties involved may need to compromise to reach a deal. Understanding these methods can help tailor the approach to suit the needs of all stakeholders. For further information or assistance, contact WOWS Global at contact@wowsglobal.com.

Remember, the method chosen should align with the goals and expectations of both entrepreneurs and investors in the financing round.