Meaning
Equity financing rounds calculate the dilution of existing shareholders before new capital is added to the company’s valuation. This process is the pre-money conversion, which dictates how convertible notes and safe agreements are converted into preferred stock during a priced round. The math of this conversion establishes the price per share by dividing the pre-money valuation by the company’s fully diluted capitalization.
This calculation applies during the transition from early debt-like instruments to formal equity.
Dilution Impact
Founders must understand this mechanism because it determines how much of the company they will own after the investment round closes. When a pre-money conversion is used, all outstanding convertible notes and safes convert before the new investor’s cash is counted. This means that the dilution caused by those notes falls entirely on the founders rather than being shared with the incoming investors.
Pricing Calculation
Calculating the conversion price involves dividing the agreed pre-money valuation by the fully diluted share count of the company. In many investment agreements, the pre-money conversion is further influenced by an unallocated option pool that must be created before the round. This requirement lowers the conversion price per share, which increases the number of shares given to the convertible holders and further dilutes the founding team.
The cost to the founders is a substantial reduction in their ownership percentage before the new investor’s funds are even received.
Investment Term
Negotiating a post-money conversion alternative is often preferred by founders to share the dilution burden more equitably. This structural choice shifts the dilution of early notes to both founders and new investors, representing a fairer division of ownership.
