# How does CAP work on convertible note?

## How does CAP work on convertible note?

Convertible notes are a type of short-term debt that can be converted, upon later financing, into equity shares of the company that issued them. If a cap or discount is not issued, then a convertible note typically converts into equity at a price equal to the equity issued during that financing round.

## Do convertible notes have a cap?

A convertible note cap sets the maximum valuation at which the investment made via the convertible note can convert into equity. Investors in the convertible note typically get converted at the lesser of the valuation of the next qualified priced round and the cap.

How do valuation caps and discounts work?

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A “valuation cap” entitles note holders to convert the outstanding balance on the note into shares of stock at the lower of (i) the valuation cap or (ii) the price per share in a qualified financing (or, if there is a discount in the note, then the discounted price per share).

How is pre-money valuation calculated?

The Pre-money valuation is equal to the Post-money valuation minus the investment amount – in this case, \$80 million ( \$100 million – \$20 million). The initial shareholders further dilute their ownership to 100/150 = 66.67\%.

### What is a cap on a note?

A cap dictates the highest price per share (PPS) that a note holder will pay for shares when the note converts at the time of a subsequent financing.

### How is convertible debt calculated?

Convertible debt is a debt hybrid product with an embedded option that allows the holder to convert the debt into equity in the future. The ratio is calculated by dividing the convertible security’s par value by the conversion price of equity.

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Do convertible notes have a valuation cap or a discount?

More often than not though, convertible notes have both a valuation cap and discount and will convert using whichever method gives the investor a lower price per share: Combining our previous examples, let’s say an issuer raises its seed round by issuing a convertible note with a \$4M valuation cap and a 20\% discount.

What is a convertible debt cap?

A convertible debt cap, also known as a valuation cap, is the maximum amount at which an investor will change his or her investment into equity. Convertible notes are a type of short-term debt that can be converted, upon later financing, into equity shares of the company that issued them.

## What is a convertible note in startup investing?

Blog > Startup Investing. A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a future financing round; in effect, the investor would be loaning money to a startup and instead of a return in the form of principal plus interest, the investor would receive equity in the company.

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## How do I calculate the valuation cap adjusted price per share?

In order to calculate the valuation cap adjusted price per share for convertible note holders, you would divide the valuation cap on the note by the pre-money valuation of the subsequent round and apply that to the Series A price per share. In this example that works out to \$3.33 per Series A share for convertible note holders.