the noteholder) usually intend for the note to convert into stock, rather than for the corporation to repay the note. 3Īlthough they are notes, both the startup and the investor (i.e. When startups sell convertible notes, the notes typically obligate the company to repay the purchase price plus interest in the event that the note has not converted by its maturity date. Convertible notes are notes issued by a corporation that convert into shares of the corporation's stock upon certain events. Notes (also referred to as promissory notes) are promises made by someone to pay a specified amount to the holder of the note (also known as the noteholder) at some time in the future, known as the maturity date. The securities of a startup can almost always be ultimately converted into common stock, so it is common to see the fully-diluted capitalization expressed as a single number of shares.Īlthough convertible notes have traditionally been popular for seed financings, the trend in Silicon Valley and other major startup ecosystems is toward safes. Some definitions of fully-diluted capitalization assume the conversion of these securities, while others do not. Another possible difference is with securities that convert into stock in connection with a preferred stock financing, such as convertible notes and safes. By contrast, these shares are almost always included in a fully-diluted capitalization in the context of equity compensation. This is commonly done when the fully-diluted capitalization is being calculated in connection with the acquisition of a startup, since startups typically do not issue equity following an acquisition. For example, un-issued shares reserved for issuance under a stock plan can be excluded from a fully-diluted capitalization. There is no single definition of fully-diluted capitalization. any shares reserved for issuance under a stock plan have been issued.Outstanding options, warrants, and other securities with a right to acquire shares have been exercised and Thus, a startup's fully-diluted capitalization commonly assumes:Īll preferred stock has been converted to common stock The term fully-diluted means that the capitalization is calculated assuming that all plans and obligations (whether outstanding or potential) to issue shares have been fulfilled. The term diluted refers to the fact that the ownership percentage represented by each share of stock is diluted each time new shares are issued. Capitalization, in this context, refers to the capital structure of a corporation - i.e. the structure of the equity and debt of a corporation. Startup investors typically calculate their percentage ownership based on the fully-diluted capitalization of the corporation. The pre-money valuation matters because it determines the percentage of the corporation an investor will receive in exchange for their investment. Pre-money valuation refers to the valuation of the startup prior to the fundraising. When fundraising, the main topic of negotiation is often the pre-money valuation used to calculate the price of stock issued to investors.
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