Valuing Early Code Contributions Before Incorporation Stock Splits
Pre-incorporation code converts to equity through intellectual property assignment agreements that balance historical replacement cost against unvested common stock.
promissory note conversion
Meaning
Debt instruments that transform into equity upon the occurrence of a specific milestone allow startups to raise capital without immediate valuation. Through promissory note conversion, investors provide cash in exchange for the right to receive shares later at a discount to the next funding round price. This mechanism stops being a debt obligation and becomes an ownership stake when the qualifying event happens.
Trigger Event
Specific conditions must be met for the transition from lender to shareholder to take place. In promissory note conversion, the most common trigger is a financing round that raises a minimum amount of new capital. Once this threshold is reached, the debt is automatically canceled and new shares are issued to the note holder.
Valuation Adjustment
Pricing for the new shares usually includes a reward for the early risk taken by the lender. During promissory note conversion, a valuation cap or a discount rate is applied to the price paid by the new investors. This ensures that the original lenders receive more shares for their money than they would if they participated in the current round.
If the company valuation is ten million dollars and the cap is five million dollars, the note converts at the lower price. This doubling of the share count for the lender accounts for the uncertainty of the early stage investment.
Equity Result
Finalization of the process results in the lender appearing on the cap table as a shareholder. After promissory note conversion, the former debt holder gains voting rights and a share in the profits. This shift changes the capital structure of the company by removing a liability and increasing the total equity.