Convertible Note Conversions: A Guide for Founders

You're closing your Series A. Your lawyers send the cap table calculations. Suddenly you're staring at numbers that don't match your mental model. That $500K convertible note from 18 months ago is now $545K because of accrued interest. Your ownership percentage just dropped another 0.5% below what you expected.

Convertible notes are more complex than most founders realize. While SAFEs have lately become the common default for many early-stage raises, convertible notes remain common.

This guide breaks down exactly how convertible note conversions work, including the mechanics most founders miss: interest accrual over time, how notes dilute each other during conversion, and what happens when things don't go according to plan.

Convertible Note Basics

Before diving into conversion mechanics, let's establish what a convertible note is and the key terms that govern how it converts.

A convertible note is a debt instrument that converts into equity at a future financing round. Until conversion, it sits on your balance sheet as a liability, not equity. Unlike SAFEs, notes accrue interest over time and carry a maturity date, creating both additional dilution and timeline pressure for founders. They remain common with institutional investors who prefer the legal protections of debt, in regions with stronger legal precedent for notes, and for bridge financing.

Every convertible note contains these core terms. Understanding each one determines how much of your company you'll give up at conversion:

1. Principal Amount: The actual investment cash that hits your bank account. This is your baseline, but not what converts.
2. Interest Rate: Accrues silently until conversion, adding to the total amount that purchases shares. This isn't like a bank loan where you make payments. Typically 6-8% annually.
3. Maturity Date: The deadline for your next funding round. If you hit maturity without a qualified financing: the note is technically due for repayment, though most investors agree to extend or convert at the cap. Either way, negotiation leverage shifts entirely to investors. Usually 18-24 months from issuance.
   • Plan your runway to close your next round 3-6 months before maturity. Notes approaching maturity create urgency that can hurt your negotiating position.
4. Valuation Cap: The maximum valuation at which the note converts, protecting early investors if your Series A values the company much higher than expected. The formula for calculating the cap price is:
   • Cap Price = Valuation Cap / Pre-money Shares Outstanding
5. Discount Rate: A percentage reduction from the Series A price per share, rewarding early investors for taking more risk. Typically 15-25%. The formula for calculating the discount price is:
   • Discount Price = Series A PPS × (1 - Discount Rate)

When Notes Convert: The Four Triggers

Notes don't convert to equity automatically when you raise. Specific contractual events trigger the conversion. The four main triggers are:

1. Qualified Financing: A priced equity round exceeding a minimum threshold (typically $1M-$2M). All notes automatically convert using their cap or discount, whichever gives investors more shares.
2. Maturity Date: If the note reaches maturity (typically 18-24 months) without a qualified financing, investors may negotiate extension, convert at the cap, or (rarely) demand repayment.
3. Change of Control: Acquisition or merger triggers immediate conversion. The note converts to equity at cap or discount, then participates in acquisition proceeds.
4. Optional Conversion: Some notes (rare) allow investors to convert at any time, typically at the valuation cap.

Why triggers matter for your dilution math: The longer it takes to reach a conversion trigger, the more interest accrues. If your Series A takes 24 months instead of 12, that's an extra year of interest adding to the converting amount.

Interest Accrual Deep Dive

Interest is the hidden dilution factor most founders underestimate. Unlike equity financing where the deal size is fixed, notes grow over time.

How Interest Adds to Principal

Every day your note is outstanding, interest accrues. At conversion, you're not converting $500K. You're converting $500K plus all accumulated interest. This total determines how many shares the investor receives.

Most convertible notes use simple interest (calculated only on the original principal, not on accumulated interest like compound interest), using this formula:

Accrued Interest = Principal × Annual Rate × (Days Outstanding / 365)

Worked Example: The Real Cost of Time

Let's model a typical note through Series A:

Initial Terms:

• Principal: $500,000
• Interest rate: 6% annually
• Time to Series A: 18 months (547 days)

Interest Calculation:

• Accrued interest = $500,000 × 0.06 × (547 / 365)
• Accrued interest = $45,000

Total Converting Amount: $500,000 + $45,000 = $545,000

That extra $45K in accrued interest adds to the number of shares the note investor will receive, diluting you and your team.

Interest Rate Impact

Different rates create vastly different outcomes over the same timeframe:

Assumes $500K principal, $2.00 Series A PPS. Interest values rounded for simplicity.

The difference between a 4% and 8% note is $30K in additional converting amount; a meaningful delta for founder ownership.

Maturity Timeframe Impact

Time is your enemy with convertible notes. Here's how a $500K note at 6% interest grows:

Assumes $500K principal, 6% interest, $2.00 Series A PPS

Every additional 6 months adds roughly $15K to the conversion amount. If your fundraise takes longer than expected, you're automatically giving up more equity.

Cap vs Discount Conversion

When your Series A closes, the note converts using whichever mechanism gives investors the lower price per share (more shares for their money). Founders often misunderstand which scenario applies.

The Two Conversion Paths

Converting at the cap:

• Cap Price = Valuation Cap / Pre-money Shares Outstanding
• Shares Received = (Principal + Interest) / Cap Price

Converting at the discount:

• Discount Price = Series A PPS × (1 - Discount Rate)
• Shares Received = (Principal + Interest) / Discount Price

The "Better Deal" Reality

Investors don't choose between cap and discount. The math automatically gives them whichever results in more shares. Here's the decision tree:

1. Calculate cap price and discount price
2. Use whichever is lower (more favorable to investor)
3. Divide total converting amount (principal + interest) by that price

Rule of thumb:

• High Series A valuation → cap wins (protects early investors)
• Modest Series A valuation → discount wins (rewards early timing)

Worked Example: Comparing Both Paths

Let's model a real scenario:

Note Terms:

• Principal: $500,000
• Interest rate: 6% annually
• Time outstanding: 12 months
• Valuation cap: $5M
• Discount rate: 20%

Interest Accrual:

• Accrued interest = $500,000 × 0.06 × 1 = $30,000
• Total converting: $530,000

Series A Terms:

• Pre-money valuation: $20M
• Pre-money shares: 10,000,000
• Price per share: $20M / 10M = $2.00

Cap Conversion Path:

• Cap Price = $5,000,000 / 10,000,000 = $0.50 per share
• Shares = $530,000 / $0.50 = 1,060,000 shares
• Ownership = 1,060,000 / (10,000,000 + 1,060,000) = 9.58%

Discount Conversion Path:

• Discount Price = $2.00 × (1 - 0.20) = $1.60 per share
• Shares = $530,000 / $1.60 = 331,250 shares
• Ownership = 331,250 / (10,000,000 + 331,250) = 3.21%

Winner: Cap ($0.50 < $1.60)

The investor receives 1,060,000 shares using the cap, more than 3× what they'd get with the discount. This is why valuation caps matter so much. In high-growth scenarios, the cap provides outsized returns to early investors.

But what happens when the Series A money actually comes in? The note converts first, then the new investment creates additional shares which dilutes everyone, including the note holder who just converted:

The note holder's 9.58% ownership at conversion becomes 7.66% after the Series A investment. The triggering round dilutes everyone, including the converting note holder.

When Discount Wins

The discount only matters when the Series A price is low relative to the cap. Rerun the example above with a $6M Series A pre-money ($0.60 PPS):

Cap path: $0.50 PPS → 1,060,000 shares (9.58%) Discount path: $0.48 PPS → 1,104,167 shares (9.94%)

Now the discount wins, giving the investor slightly more shares. But notice: in lower valuation scenarios, the difference is smaller. The cap creates asymmetric upside for investors in breakout companies.

Multiple Notes Converting Together

Here's where convertible note mechanics surprise even experienced founders: notes dilute each other during conversion. Unlike SAFEs, which convert simultaneously without mutual dilution, notes convert sequentially and the order matters depending on how your notes are written.

Why Notes Dilute Each Other

Each note calculates its conversion price based on the pre-money share count at the moment it converts. When Note 1 converts and adds shares to the cap table, Note 2's conversion price calculation includes those new shares in the denominator. This creates a cascading dilution effect.

The mechanism:

1. Note 1 converts at cap price = Cap / Pre-money Shares
2. Note 1 shares are added to the cap table
3. Note 2 converts at cap price = Cap / (Pre-money Shares + Note 1 Shares)
4. The denominator is larger, so the price per share is higher
5. Note 2 gets fewer shares per dollar than Note 1

Detailed Example: Three Notes Converting (Simple)

Let's start with a simple scenario with multiple notes, issued at the same time, at different caps:

Pre-Series A Cap Table:

• Shares outstanding: 5,000,000
• All notes issued 12 months ago (for simplicity)

Note Terms:

• Note 1: $150,000 principal, 6% interest, $4M cap
• Note 2: $350,000 principal, 6% interest, $6M cap
• Note 3: $500,000 principal, 6% interest, $8M cap

Series A Terms:

• Pre-money valuation: $20M

Interest Calculation (all 12 months):

• Note 1: $150,000 × 0.06 = $9,000 → $159,000 total
• Note 2: $350,000 × 0.06 = $21,000 → $371,000 total
• Note 3: $500,000 × 0.06 = $30,000 → $530,000 total

Sequential Conversion Process

Note 1 Converts First (lowest cap):

• Cap Price = $4,000,000 / 5,000,000 = $0.80 per share
• Shares = $159,000 / $0.80 = 198,750 shares
• New Total Shares = 5,000,000 + 198,750 = 5,198,750

Note 2 Converts Second:

• Cap Price = $6,000,000 / 5,198,750 = $1.154 per share
• Shares = $371,000 / $1.154 = 321,489 shares
• New Total Shares = 5,198,750 + 321,489 = 5,520,239

Notice: Note 2's cap price ($1.154) is 44% higher than Note 1's cap price ($0.80) because the denominator includes Note 1's shares.

Note 3 Converts Third:

• Cap Price = $8,000,000 / 5,520,239 = $1.449 per share
• Shares = $530,000 / $1.449 = 365,769 shares
• New Total Shares = 5,520,239 + 365,769 = 5,886,008

Note 3's cap price is now 81% higher than Note 1's original cap price.

Summary of Dilution Impact (Simple)

Key insight: Despite investing $1M in principal, these notes collectively receive 886,008 shares. Not the 1,060,000 shares you'd calculate by naively dividing total converting amount by the first note's cap price. The sequential dilution costs later investors roughly 174,000 shares.

Detailed Example: Three Notes Converting (Realistic)

In practice, notes with different caps are rarely issued simultaneously. Let's model the same scenario with staggered timing:

Pre-Series A Cap Table:

• Shares outstanding: 5,000,000

Note Terms (staggered issuance):

• Note 1: $150,000 principal, 6% interest, $4M cap, issued 18 months ago
• Note 2: $350,000 principal, 6% interest, $6M cap, issued 12 months ago
• Note 3: $500,000 principal, 6% interest, $8M cap, issued 6 months ago

Series A Terms:

• Pre-money valuation: $20M

Interest Calculation (staggered):

• Note 1: $150,000 × 0.06 × 1.5 = $13,500 → $163,500 total
• Note 2: $350,000 × 0.06 × 1.0 = $21,000 → $371,000 total
• Note 3: $500,000 × 0.06 × 0.5 = $15,000 → $515,000 total

Sequential Conversion Process

Note 1 Converts First (lowest cap):

• Cap Price = $4,000,000 / 5,000,000 = $0.80 per share
• Shares = $163,500 / $0.80 = 204,375 shares
• New Total Shares = 5,204,375

Note 2 Converts Second:

• Cap Price = $6,000,000 / 5,204,375 = $1.153 per share
• Shares = $371,000 / $1.153 = 321,780 shares
• New Total Shares = 5,526,155

Note 3 Converts Third:

• Cap Price = $8,000,000 / 5,526,155 = $1.448 per share
• Shares = $515,000 / $1.448 = 355,668 shares
• New Total Shares = 5,881,823

Summary of Dilution Impact (Realistic)

Common Pitfalls

Avoid these mistakes to save yourself from unpleasant surprises when your notes convert.

Modeling only principal: Founders build dilution models using note principal ($500K) without accounting for interest. After 18 months at 6%, that $500K converts at $545K (9% more dilution than expected). Always model total converting amount (principal + estimated interest) based on realistic Series A timing.

Treating caps as valuations: A $5M cap doesn't mean your company is "valued at $5M." The cap is a conversion ceiling, not a valuation. If you raise at $20M, investors still convert at $5M pricing, receiving 4× more shares than Series A investors per dollar invested. Model ownership impact at 2-3× your target Series A valuation.

Poor timing around maturity: Closing a priced round just before notes mature means you've triggered conversion with maximum interest accumulation and potentially rushed into a lower Series A valuation. Plan to close 3-6 months before maturity. If you do hit maturity, expect extension requests that impact ownership.

Ignoring sequential conversion: Convertible notes dilute each other during conversion. Later notes get worse pricing as earlier conversions increase the share count. When raising follow-on notes, document conversion priority explicitly and use the same cap (or higher) to maintain fairness.

Excessive interest rates: Standard range is 4-8% for early-stage notes. Higher rates are only justified for very high-risk bridge notes with short duration.

Skipping conversion priority clarity: Before signing, confirm the conversion order if multiple notes exist or are planned, the qualified financing threshold triggering conversion, and what vote threshold is required to amend terms. Ambiguity here creates disputes at Series A.

Underestimating option pool impact: Series A investors typically require a 10-20% option pool on a pre-money basis, which dilutes everyone including converted note holders. Many founders model note conversions and realize they have no room for a meaningful pool without severe founder dilution. Plan the option pool first, then size your notes accordingly. Discuss this explicitly with note investors so they understand their post-Series A ownership will account for this.

Convertible Note Cap Table Health Check

Before signing your next note, run through this quick assessment to ensure your terms are reasonable for your stage:

If your metrics fall outside these ranges, revisit your terms before signing. Multiple warning signs indicate an investor-unfriendly deal that can haunt you through future fundraising rounds.

Key Takeaways

Here's what founders need to remember when convertible notes are on the table:

1. Convertible notes are debt Notes accrue interest and carry maturity deadlines; SAFEs don't. This single distinction drives everything: interest adds to your conversion amount, maturity creates negotiation pressure, and legal complexity is higher.
2. Interest accrual is automatic dilution Every day your note is outstanding, interest accumulates and adds to the total amount that converts into shares. Model your total accrued interest conversion from day one, not just the principal.
3. Sequential conversion creates mutual dilution Each note converts against an increasing share base. Note #3 might get 30% fewer shares than Note #1 from the same investment. Conversion order matters, your note documents should specify priority clearly.
4. Cap vs discount: Investors always win both ways The conversion mechanism automatically selects whichever gives investors more shares. High Series A valuations trigger cap conversion that are often 3-5× more shares than discount conversion. Always model your convertible note conversion at multiple valuations.
5. Converted notes get diluted by the triggering round Note holders convert into their ownership percentage first, then immediately get diluted by the new priced round investment. A 9.58% note holder might drop to 7.66% post-Series A after new investors buy their stake.
6. Convertible note maturity timing is strategic, not administrative Close your Series A 3-6 months before notes mature. Maturity pressure costs you negotiating leverage and often triggers dilutive requests from investors. Plan runway accordingly.
7. Plan your option pool before signing notes Series A investors typically require a 10-15% option pool on a pre-money basis, which dilutes everyone including converted note holders. Factor this into your dilution models before finalizing any note terms.
8. Market-standard terms protect both sides Healthy ranges: 4-8% interest, 18-24 months maturity, 15-25% discount. Terms outside these ranges (especially 10%+ interest or automatic conversion triggers) signal misaligned investors. Red flags early save dilution later.
9. Model early, model often Every fundraising delay increases accrued interest. Every additional note adds sequential dilution complexity. Use a cap table calculator to scenario-plan before signing terms you can't change.
10. Legal validation catches modeling errors Request full convertible note conversion calculations from lawyers 30+ days before closing. Founders regularly find discrepancies in interest accrual methods, conversion priorities, or share count math. Your spreadsheet might be wrong, make sure to verify.

---

Ready to model your convertible note scenarios? Our free cap table tool lets you experiment with different caps, discounts, and interest rates to see exactly how your notes will convert. Add your outstanding notes, input your expected Series A terms, and instantly see your dilution. No spreadsheet formulas required.

Try the Cap Table Calculator →

Understanding convertible note mechanics gives you control over one of the most complex sources of dilution in your cap table. Model early, model often, and remember: the interest clock is always running.