Meaning
Contractual instructions dictate the precise way debt instruments or simple agreements for future equity transform into capital shares during a financing event. The equity conversion mechanics specify whether the transition occurs at a fixed price or a discount to the current valuation. These rules ensure that all parties understand the final ownership percentages before the transaction closes.
Calculations usually involve the total share count on a fully diluted basis.
Calculation Logic
Mathematical formulas define how the principal and interest of a loan turn into a specific number of shares. This process often includes a valuation cap that protects the holder from excessive dilution if the company valuation grows rapidly. The formula divides the investment amount by the lower of the capped price or the discounted round price.
This logic must be applied consistently to every instrument in the same class.
Price Trigger
Reaching a specific dollar amount in a qualifying financing round initiates the change from debt to ownership. The documentation must state the exact threshold required to force this transition. Without a clear trigger, the instruments might remain as liabilities on the ledger indefinitely.
Dilution Effect
Every participant in the capital structure sees their percentage of ownership change when the transition occurs. The record must show the impact on the existing founders and employees. Calculations performed at this stage prevent future disagreements about the remaining available equity.
