This is an opinion piece by Rickard Vernet, investor and legal expert with a long background helping startups. He has a background at Vinge (law firm), Pale blue dot (VC fund) and is now at Bolago (formerly known as StartupTools) where he works with creating legal tools for startups and growth companies. Rickard is also co-founder of NaturaTua, a startup enabling private investments in biodiversity.
Let’s take a startup with the two founders holding 2,000,000 shares, raising €500,000 through a convertible note with a 20% discount (ignoring interest, which if applicable would just get added to the conversion amount).
A new investor enters with €1.5 million at a pre-money valuation of €10 million. The price per share (“PPS”) for the new investor would w/o the convertible be calculated as:
(Pre-money valuation/number of Outstanding shares) = 10,000,000/2,000,000 = €5
This would give:
- new investor (Investment/PPS) = 1,500,000/5 = 300,000 shares
- the noteholder (conversion amount/(PPS*(1-discount)) = 500,000/(5*((1-0.2)) = 125,000 shares
Meaning that the ownership would post-round be:
- founders 2,000,000 shares = 82,47%
- noteholder 125,000 shares = 5,15%
- new investor 300,000 shares =12,37%
Only this is NOT what you can expect to actually happen.
The new investor will almost certainly ask that their post investment ownership is equal to investment/(pre-money valuation + new investment), or in other words that existing convertibles are “included in the pre-money valuation” (and so does not dilute the new investor).
In our example, this would be €1,500,000/(€10,000,000 + €1,500,000) = 13,04%.
To effectuate this, the calculation for the new investor’s PPS would therefore instead be: Pre-money valuation/(number of Outstanding shares + conversion shares).
As you can see this is a circular calculation, where the PPS depends on the number of conversion shares, and the number of conversion shares depends on the PPS. And a lower PPS is also beneficial to the converting noteholder.
In our example we would get the following result:
- PPS for the new investor: €4,69
- New investor shares (Investment/PPS) = 1,500,000/4,69 = 320,000
- Noteholder shares (conversion amount/(PPS*(1-discount)) = 500,000/(4,69*((1-0.2)) = 133,333
Meaning that the ownership would post-round be:
- founders 2,000,000 shares = 81,52%
- noteholder 125,000 shares = 5,43%
- new investor 300,000 shares =13,04%
Stay tuned for more insight and perspectives from Rickard in the future.
