While note conversion terms can be written in slightly different ways, for our purposes, we will use a simple example where the stock price using the valuation cap conversion option was specified to be calculated as follows: Valuation cap divided by the issued and outstanding securities immediately prior to the sale of the preferred. The valuation cap was $3M. The number of issued and outstanding securities was 10,345,000 per the cap table in Figure 3. The price per share is therefore $3M/10,345,000 or $0.28999517.
The 5% interest on the $400K in notes would have generated an additional $20K in the intervening year, so the convertible note investors will be converting $420K into shares at $0.28999517. Running the math, the convertible note holders will get $420K/$0.28999517 = 1,448,299 shares. So the conversion of the notes before any other actions would have the cap table looking like this:
Figure 4: Cap Table Accounting for the Conversion of the Convertible Notes
|Shares or Options||Issued and Outstanding||Fully Diluted|
|Convertible Note Investors||1,448,299||12.28%||11.19%|
|Issued and Outstanding||11,793,299||100.00%|
|Option Pool Available||1,155,000||8.92%|
|Total Fully Diluted||12,948,299||100.00%|