Meaning
Mathematical ratio used to determine the amount of ownership granted in exchange for convertible debt or preferred instruments. Calculating the equity conversion rate depends on the agreed valuation cap and the discount rate specified in the initial contract. This formula determines the final share count for early lenders.
Derivation Method
Assessing the conversion price involves comparing the original loan terms to the price paid by new investors. When a funding round triggers the conversion, the debt holder receives shares at a lower price than new arrivals. This provides a reward for the risk taken by providing capital before the venture was proven.
Calculation Logic
If a note has a cap of five million and the next round happens at ten million, the rate favors the early lender. The formula divides the investment amount by the conversion price per share. A high equity conversion rate results in more shares being issued, which increases the dilution for the existing holders.
Founders must track these potential shifts to understand their remaining stake after a round closes.
Liquidity Outcome
The final tally of shares determines the payout order and amount during an exit. Proper management of this ratio prevents unexpected loss of control during complex financing events.
