{"id":29133,"date":"2024-05-16T11:10:07","date_gmt":"2024-05-16T16:10:07","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/?post_type=biws_kb&#038;p=29133"},"modified":"2024-12-29T23:51:16","modified_gmt":"2024-12-30T04:51:16","slug":"convertible-notes","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/convertible-notes\/","title":{"rendered":"Convertible Notes for Startups Explained: Definition, Calculations, Excel Examples, and Comparison to SAFE Notes"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Convertible Notes for Startups Explained: Definition, Calculations, Excel Examples, and Comparison to SAFE Notes<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/convertible-notes\/#Part_1_Convertible_Notes_in_a_Seed_Round\">Part 1: Convertible Notes in a Seed Round<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/convertible-notes\/#Part_2_Convertible_Note_Conversions_in_a_Series_A_Round_Valuation_Caps_and_Conversion_Discounts_with_an_Options_Pool\">Part 2: Convertible Note Conversions in a Series A Round (Valuation Caps and Conversion Discounts) with an Options Pool<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/convertible-notes\/#Part_3_Convertible_Notes_and_SAFE_Notes_Side-by-Side\">Part 3: Convertible Notes and SAFE Notes Side-by-Side<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/convertible-notes\/#Part_4_Are_Convertible_Notes_or_SAFE_Notes_Ever_Worth_It\">Part 4: Are Convertible Notes or SAFE Notes Ever Worth It?<\/a><\/li><\/ul><\/nav><\/div>\n\n<blockquote><p><strong>Convertible Notes Definition:<\/strong> With Convertible Notes, startup investors contribute capital but do <u>not<\/u> receive direct ownership in the startup right away; instead, they earn interest and receive their shares later based on a conversion of the loan principal into equity when the company raises a \u201cpriced round\u201d based on a specific valuation.<\/p><\/blockquote>\n<p>Just like SAFE Notes, in theory, Convertible Notes are <strong>faster and cheaper <\/strong>than traditional equity rounds, such as Seed or Series A funding linked to agreed-upon valuations. They are quite different from <a href=\"https:\/\/breakingintowallstreet.com\/kb\/leveraged-buyouts-and-lbo-models\/convertible-preferred-stock\/\" target=\"_blank\" rel=\"noopener\">Convertible Preferred Stock<\/a>, which is typically used by larger public companies.<\/p>\n<p>Valuation discussions and share grants are deferred until these priced rounds take place \u2013 though other conversion\/trigger mechanisms may be defined for Convertible Notes.<\/p>\n<p>Unlike <a href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/safe-notes\/\" target=\"_blank\" rel=\"noopener\">SAFE Notes<\/a>, Convertible Notes are <strong>clearly Debt<\/strong> and have a well-defined space in the seniority and capital structure.<\/p>\n<p>As a result, they avoid some of the problems that SAFE Notes create and tend to be more favorable for <strong>investors<\/strong>.<\/p>\n<p>For startups, however, Convertible Notes potentially create <strong>more dilution<\/strong> because the interest often accrues to the loan principal \u2013 meaning that the investors get more shares upon conversion due to this higher principal:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29134 size-full\" title=\"Convertible Note Dilution\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110404\/01-Convertible-Note-Dilution.jpg\" alt=\"Convertible Note Dilution\" width=\"1157\" height=\"634\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110404\/01-Convertible-Note-Dilution.jpg 1157w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110404\/01-Convertible-Note-Dilution-300x164.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110404\/01-Convertible-Note-Dilution-1024x561.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110404\/01-Convertible-Note-Dilution-768x421.jpg 768w\" sizes=\"(max-width: 1157px) 100vw, 1157px\" \/><\/p>\n<p>You can get our simple Convertible Notes Excel model and presentation and read this entire tutorial in written format below:<\/p>\n<p><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Startups-VC\/Convertible-Notes\/Convertible-Notes-vs-Safe-Notes.xlsx\" target=\"_blank\" rel=\"noopener\">Convertible Notes vs. SAFE Notes \u2013 Excel Model (XL)<\/a><\/p>\n<p><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Startups-VC\/Convertible-Notes\/Convertible-Notes-Slides.pdf\" target=\"_blank\" rel=\"noopener\">Convertible Notes \u2013 Presentation Slides (PDF)<\/a><\/p>\n<h3><strong>Video Table of Contents:<\/strong><\/h3>\n<p><strong>5:19:<\/strong> Part 1: Convertible Notes in a Seed Round<\/p>\n<p><strong>6:01:<\/strong> Part 2: Conversions in the Series A with an Options Pool<\/p>\n<p><strong>10:47:<\/strong> Dollars Invested Method<\/p>\n<p><strong>11:41:<\/strong> Part 3: Side-by-Side: Convertible Note vs. SAFE<\/p>\n<p><strong>12:35:<\/strong> Part 4: Should a Startup Use Either One of These?<\/p>\n<p><strong>13:32:<\/strong> Recap and Summary<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Part_1_Convertible_Notes_in_a_Seed_Round\"><\/span><strong>Part 1: Convertible Notes in a Seed Round<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>If a startup raises capital via Convertible Notes in a Seed Round, <strong>nothing changes<\/strong> in the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/capitalization-table\/\" target=\"_blank\" rel=\"noopener\">capitalization table (\u201ccap table\u201d)<\/a> because the investors do not receive direct ownership.<\/p>\n<p>So, if a Seed Investor invests $2 million via Convertible Notes, and the co-founders own 90% with the employees owning 10%, the ownership percentages remain 90% and 10% before and after the deal:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29135 size-full\" title=\"Convertible Note Terms\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110446\/02-Convertible-Note-Terms.jpg\" alt=\"Convertible Note Terms\" width=\"1336\" height=\"770\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110446\/02-Convertible-Note-Terms.jpg 1336w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110446\/02-Convertible-Note-Terms-300x173.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110446\/02-Convertible-Note-Terms-1024x590.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110446\/02-Convertible-Note-Terms-768x443.jpg 768w\" sizes=\"(max-width: 1336px) 100vw, 1336px\" \/><\/p>\n<p>There are terms associated with these Convertible Notes \u2013 namely the <strong>valuation cap<\/strong> and <strong>conversion discount<\/strong> \u2013 but these only take effect in the next <strong>priced round<\/strong> when the startup raises capital at a specific valuation.<\/p>\n<p><em>Unlike<\/em> the SAFE Notes, an <strong>interest rate and maturity date<\/strong> are also attached to these Convertible Notes.<\/p>\n<p>Here, we assume 2 years between the Seed Round and Series A round, but in real life, you would model this based on the dates of the maturity and the next priced round.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Part_2_Convertible_Note_Conversions_in_a_Series_A_Round_Valuation_Caps_and_Conversion_Discounts_with_an_Options_Pool\"><\/span><strong>Part 2: Convertible Note Conversions in a Series A Round (Valuation Caps and Conversion Discounts) with an Options Pool<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>We\u2019ll assume here that this startup plans to raise <strong>$5 million at a $10 million pre-money valuation.<\/strong><\/p>\n<p>That means the post-money valuation is $5 + $10 = $15 million, so the VC firm <em>expects<\/em> to own ~33% of the company:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29136 size-full\" title=\"Series A Ownership with a Convertible Note\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110509\/03-Series-A-Ownership.jpg\" alt=\"Series A Ownership with a Convertible Note\" width=\"1357\" height=\"202\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110509\/03-Series-A-Ownership.jpg 1357w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110509\/03-Series-A-Ownership-300x45.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110509\/03-Series-A-Ownership-1024x152.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110509\/03-Series-A-Ownership-768x114.jpg 768w\" sizes=\"(max-width: 1357px) 100vw, 1357px\" \/><\/p>\n<p><strong>But in reality, the VC firm investing $5 million in this Series A round will own less than 33% because of the shares that go to the Convertible Note investors<\/strong>.<\/p>\n<p>Here\u2019s the step-by-step process to set up the cap table:<\/p>\n<h3><strong>Step 1: Calculate the \u201cPrice per Share\u201d in the Series A Round<\/strong><\/h3>\n<p>This is based on the pre-money valuation divided by the Pre-Money Share Count (the shares that existed <em>before<\/em> the Series A):<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29137 size-full\" title=\"Series A Share Price\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110540\/04-Series-A-Share-Price.jpg\" alt=\"Series A Share Price\" width=\"1209\" height=\"338\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110540\/04-Series-A-Share-Price.jpg 1209w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110540\/04-Series-A-Share-Price-300x84.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110540\/04-Series-A-Share-Price-1024x286.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110540\/04-Series-A-Share-Price-768x215.jpg 768w\" sizes=\"(max-width: 1209px) 100vw, 1209px\" \/><\/p>\n<p>It\u2019s $7.50 here, which means the Series A investors pay $7.50 for each new share they purchase in this round.<\/p>\n<h3><strong>Step 2: Determine the \u201cPrice per Share\u201d for the Convertible Note Investors<\/strong><\/h3>\n<p>This is where the <strong>conversion discount<\/strong>, <strong>valuation cap<\/strong>, and <strong>accrued interest <\/strong>come into play.<\/p>\n<p>First, you must calculate the <strong>Convertible Note principal<\/strong> factoring in the 10% accrued interest over 2 years, which equals $2.42 million here:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29138 size-full\" title=\"Convertible Note Accrued Interest Effect\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110601\/05-Convertible-Note-Accrued-Interest.jpg\" alt=\"Convertible Note Accrued Interest Effect\" width=\"1304\" height=\"584\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110601\/05-Convertible-Note-Accrued-Interest.jpg 1304w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110601\/05-Convertible-Note-Accrued-Interest-300x134.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110601\/05-Convertible-Note-Accrued-Interest-1024x459.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110601\/05-Convertible-Note-Accrued-Interest-768x344.jpg 768w\" sizes=\"(max-width: 1304px) 100vw, 1304px\" \/><\/p>\n<p>If there\u2019s a <strong>conversion discount<\/strong>, the Convertible Note investors get their shares at a discount to the $7.50 the Series A investors pay (a 20% discount in this case, which means $6.00 per share).<\/p>\n<p>If there\u2019s a <strong>valuation cap<\/strong>, the Convertible Note investors get their shares at a price equal to the Valuation Cap \/ Pre-Money Shares, or $10 million \/ 1.333 million = $7.50 here.<\/p>\n<h3><strong>Step 3: Grant Shares to the New Investors in the Round<\/strong><\/h3>\n<p>In a case like this with <strong>both<\/strong> a discount and a cap, we take the <em>best possible share price<\/em> for the Convertible Note investors and use that to calculate the shares granted:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29139 size-full\" title=\"Shares from the Convertible Note Conversion\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110628\/06-Convertible-Note-Shares.jpg\" alt=\"Shares from the Convertible Note Conversion\" width=\"1620\" height=\"460\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110628\/06-Convertible-Note-Shares.jpg 1620w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110628\/06-Convertible-Note-Shares-300x85.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110628\/06-Convertible-Note-Shares-1024x291.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110628\/06-Convertible-Note-Shares-768x218.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110628\/06-Convertible-Note-Shares-1536x436.jpg 1536w\" sizes=\"(max-width: 1620px) 100vw, 1620px\" \/><\/p>\n<p>The Series A investors get their 666,667 new shares from the $7.50 per share they pay.<\/p>\n<p>The <strong>valuations<\/strong> are based on the $7.50 Series A share price times each group&#8217;s share count.<\/p>\n<div class='code-block code-block-9' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/22172829\/vc-tile.png\" alt=\"Venture Capital & Growth Equity Modeling\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Model and Value Startups, Understand Cap Tables, and Prepare for VC Interviews<\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Evaluate companies and deals like a pro<\/h4>\n              <p>You\u2019ll understand cap tables, startup\/growth valuations, and exits<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Master financial modeling<\/h4>\n            <p>You\u2019ll build forecasts and analyze metrics for tech and biotech startups<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 9 case studies<\/h4>\n            <p>You\u2019ll learn the numbers and how to make investment recommendations\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/venture-capital-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Venture-Capital-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div>\n<\/div>\n\n<h3><strong>Step 4: Build in Dilution from the Options Pool<\/strong><\/h3>\n<p>The <strong>employee<\/strong> <strong>options pool<\/strong> is usually <strong>upsized or re-sized<\/strong> in a priced round, which creates additional complications because now the employees effectively get \u201cfree shares.\u201d<\/p>\n<p>To calculate the impact, start with the <strong>total non-option shares<\/strong> after the Convertible Note conversions and Series A funding, which in this case are 1.070 million + 1.333 million = 2.270 million.<\/p>\n<p>Then, divide this by <strong>1 \u2013 Options Pool %<\/strong>, where \u201cOptions Pool %\u201d is the <u>total<\/u> percentage of the company shares that employees should own:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29140 size-full\" title=\"Options Pool Post-Conversion\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110653\/07-Options-Pool.jpg\" alt=\"Options Pool Post-Conversion\" width=\"1270\" height=\"220\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110653\/07-Options-Pool.jpg 1270w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110653\/07-Options-Pool-300x52.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110653\/07-Options-Pool-1024x177.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110653\/07-Options-Pool-768x133.jpg 768w\" sizes=\"(max-width: 1270px) 100vw, 1270px\" \/><\/p>\n<p>The employees should have 20% * 2,837,500 = 567,500 shares after this round, and they already have 133,333 options.<\/p>\n<p>Therefore, they receive 567,500 \u2013 133,333 = 434,167 additional options in this round, which count as \u201cfree shares.\u201d<\/p>\n<p>This further dilutes the Series A investors down to <strong>~24% ownership:<\/strong><\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29141 size-full\" title=\"Series A Ownership Dilution After the Convertible Note Shares\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110716\/08-Series-A-Ownership-Dilution.jpg\" alt=\"Series A Ownership Dilution After the Convertible Note Shares\" width=\"1314\" height=\"492\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110716\/08-Series-A-Ownership-Dilution.jpg 1314w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110716\/08-Series-A-Ownership-Dilution-300x112.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110716\/08-Series-A-Ownership-Dilution-1024x383.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110716\/08-Series-A-Ownership-Dilution-768x288.jpg 768w\" sizes=\"(max-width: 1314px) 100vw, 1314px\" \/><\/p>\n<h3><strong>Step 5: Link in the Post-Series A Cap Table and Calculate the Ownership Percentages<\/strong><\/h3>\n<p>Based on these new share counts, we can calculate each group\u2019s ownership and share value (shown above).<\/p>\n<p>The Series A investors own <strong>less than 33%<\/strong> because the Seed Investors got their shares \u201cfor free\u201d in this round based on their previous investment.<\/p>\n<p>Therefore, the \u201ctrue\u201d Pre-Money Valuation was higher.<\/p>\n<p>Because of this issue, people have developed different ways to determine the number of shares that Convertible Notes convert into.<\/p>\n<p>For example, they might use the \u201cDollars Invested\u201d method, a weighted average of the share prices, or another method to find a middle ground between the investor groups.<\/p>\n<p>You can see an example of the \u201cDollars Invested\u201d method below:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29142 size-full\" title=\"Dollars Invested Method for the Convertible Note Shares\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110751\/09-Dollars-Invested-Method.jpg\" alt=\"Dollars Invested Method for the Convertible Note Shares\" width=\"1150\" height=\"722\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110751\/09-Dollars-Invested-Method.jpg 1150w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110751\/09-Dollars-Invested-Method-300x188.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110751\/09-Dollars-Invested-Method-1024x643.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110751\/09-Dollars-Invested-Method-768x482.jpg 768w\" sizes=\"(max-width: 1150px) 100vw, 1150px\" \/><\/p>\n<p>Effectively, it produces a <strong>lower \u201ctrue\u201d pre-money valuation<\/strong> by subtracting some of the Convertible Note.<\/p>\n<p>As a result, both the Convertible Note and Series A investors end up with higher ownership and the Co-Founders get more heavily diluted:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29143 size-full\" title=\"Ownership with the Dollars Invested Method\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110821\/10-Dollars-Invested-Ownership.jpg\" alt=\"Ownership with the Dollars Invested Method\" width=\"1424\" height=\"552\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110821\/10-Dollars-Invested-Ownership.jpg 1424w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110821\/10-Dollars-Invested-Ownership-300x116.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110821\/10-Dollars-Invested-Ownership-1024x397.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110821\/10-Dollars-Invested-Ownership-768x298.jpg 768w\" sizes=\"(max-width: 1424px) 100vw, 1424px\" \/><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Part_3_Convertible_Notes_and_SAFE_Notes_Side-by-Side\"><\/span><strong>Part 3: Convertible Notes and SAFE Notes Side-by-Side<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>The most obvious difference is that Convertible Notes create more dilution due to the accrued interest:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29144 size-full\" title=\"Dilution from the Convertible Note vs. SAFE Note\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110855\/11-SAFE-vs-Convertible-Note-Dilution.jpg\" alt=\"Dilution from the Convertible Note vs. SAFE Note\" width=\"1411\" height=\"341\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110855\/11-SAFE-vs-Convertible-Note-Dilution.jpg 1411w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110855\/11-SAFE-vs-Convertible-Note-Dilution-300x73.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110855\/11-SAFE-vs-Convertible-Note-Dilution-1024x247.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110855\/11-SAFE-vs-Convertible-Note-Dilution-768x186.jpg 768w\" sizes=\"(max-width: 1411px) 100vw, 1411px\" \/><\/p>\n<p>But this doesn\u2019t tell the whole story, as the Convertible Notes also have advantages in a shutdown or company liquidation.<\/p>\n<p>Their place in the capital structure is very clear (they are senior to the Preferred and Common Equity Investors), and they have the first claim to the company\u2019s assets.<\/p>\n<p>Therefore, while Convertible Note investors are unlikely to recover much in a liquidation, they <em>might<\/em> recover some of their principal, while the SAFE Note and priced equity investors would get nothing.<\/p>\n<p>Also, Convertible Notes, similar to <a href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/divestitures\/\" target=\"_blank\" rel=\"noopener\">Venture Debt<\/a>, can sometimes act as \u201cmini-bridge loans\u201d between priced rounds, which is rare for SAFE Notes.<\/p>\n<p>Here\u2019s a full comparison table:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29145 size-full\" title=\"Convertible Note vs. SAFE Note Comparison Table\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110925\/12-SAFE-vs-Convertible-Note-Table.jpg\" alt=\"Convertible Note vs. SAFE Note Comparison Table\" width=\"2422\" height=\"1206\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110925\/12-SAFE-vs-Convertible-Note-Table.jpg 2422w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110925\/12-SAFE-vs-Convertible-Note-Table-300x149.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110925\/12-SAFE-vs-Convertible-Note-Table-1024x510.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110925\/12-SAFE-vs-Convertible-Note-Table-768x382.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110925\/12-SAFE-vs-Convertible-Note-Table-1536x765.jpg 1536w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/16110925\/12-SAFE-vs-Convertible-Note-Table-2048x1020.jpg 2048w\" sizes=\"(max-width: 2422px) 100vw, 2422px\" \/><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Part_4_Are_Convertible_Notes_or_SAFE_Notes_Ever_Worth_It\"><\/span><strong>Part 4: Are Convertible Notes or SAFE Notes <em>Ever<\/em> Worth It?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>In short, <strong>no<\/strong>, not really.<\/p>\n<p>Both instruments had advantages in past years (SAFE Notes were introduced in 2013), but most of these advantages have diminished over time.<\/p>\n<p>Priced equity rounds have become simpler and cheaper to execute, and they don\u2019t create messy cap tables, unclear valuations, or accrued interest with higher dilution in the same way these \u201cdeferred\u201d instruments do.<\/p>\n<p><strong>Convertible Notes<\/strong> are more favorable to investors due to the maturity and full repayment, varied conversion triggers, accrued interest, and seniority.<\/p>\n<p>From the co-founders\u2019 perspective, however, Convertible Notes usually mean more dilution and don\u2019t necessarily provide a big benefit unless the company shuts down.<\/p>\n<p>So, priced equity rounds are still superior in most cases, and if a startup needs a bridge loan, Venture Debt could work quite well.<\/p>\n<p>Convertible Notes and SAFE Notes should be in the \u201cInteresting and good to know, but not necessarily a top priority\u201d category when you\u2019re considering startup funding options.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>With Convertible Notes, startup investors contribute capital but do not receive direct ownership in the startup right away; instead, they earn interest and receive their shares later based on a conversion of the loan principal into equity when the company raises a \u201cpriced round\u201d based on a specific valuation.<\/p>\n","protected":false},"featured_media":0,"template":"","class_list":["post-29133","biws_kb","type-biws_kb","status-publish","hentry","kb_category-venture-capital"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/29133","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=29133"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}