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Convertible Note Pro Formas: Modeling Conversion Scenarios Step by Step

Why Pro Formas Matter for Convertible Notes

A convertible note pro forma is a projection of your cap table after the note converts to equity at your Series A. It answers: "How much will this note dilute my ownership?" Most founders avoid building these models because they seem complex, but the math is straightforward once you understand the flow.

Without a pro forma, you're signing convertible notes blind—you don't actually know what ownership percentage you'll lose. This is how founders end up shocked at Series A close, discovering they're more diluted than expected.

Step 1: Establish Your Current Cap Table

Start with your founder equity. Let's say you and a co-founder each own 50% of 1 million authorized shares. That's 500,000 shares each. Document all outstanding options (employee grants), warrants, and any other equity claims.

If you've reserved 20% of your cap table for employee options, that's 200,000 shares in the option pool. These shares don't have an owner yet, but they count toward your fully diluted capitalization.

Your starting cap table: Founder A: 500,000 shares (50%). Founder B: 500,000 shares (50%). Option pool: 200,000 shares (20% reserved, unallocated). Total outstanding: 1,000,000 shares. Fully diluted: 1,200,000 shares (assuming you'll authorize that many).

Step 2: List All Convertible Notes with Terms

Document each convertible note separately: investment amount, valuation cap, discount rate, and interest rate (if any). Let's model two notes for simplicity:

Note 1: $150,000, $2.5M cap, 20% discount, 2% interest (accrued)

Note 2: $100,000, $3M cap, 15% discount, 2% interest (accrued)

Note 1 has accrued interest of $3,000 (2 years × 2% = 4% of $150K). Total owed at conversion: $153,000.

Note 2 has accrued interest of $2,000. Total owed at conversion: $102,000.

Step 3: Project Your Series A Scenario

Estimate where your Series A valuation might land. Let's model three scenarios: base case ($6M post-money), optimistic ($10M post-money), and conservative ($4M post-money).

For each scenario, you need:

• Post-money valuation (total company value after Series A investment)
• Series A investment amount (use $1M as a typical raise)
• Share price per share = Post-money ÷ total shares pre-Series A

Step 4: Calculate Note Conversions—Base Case

Base case: $6M post-money Series A, $1M investment.

Your pre-Series A fully diluted shares: 1,200,000 (from Step 1)

Share price at Series A: $6M ÷ 1,200,000 = $5.00 per share

Note 1 conversion: $153,000 owed. Apply 20% discount: $5.00 × 80% = $4.00 per share. Shares issued: 153,000 ÷ $4.00 = 38,250 shares.

But check the cap: $2.5M cap means the effective share price is $2.5M ÷ 1,200,000 = $2.08 per share. At the cap: 153,000 ÷ $2.08 = 73,558 shares.

Use whichever gives more shares to the investor: the discount gives 38,250, the cap gives 73,558. The cap is more favorable. Note 1 converts to 73,558 shares.

Note 2 conversion: $102,000 owed. Apply 15% discount: $5.00 × 85% = $4.25 per share. Shares issued: 102,000 ÷ $4.25 = 23,994 shares.

Check the cap: $3M cap means $3M ÷ 1,200,000 = $2.50 per share. At the cap: 102,000 ÷ $2.50 = 40,800 shares.

The cap is more favorable (40,800 > 23,994). Note 2 converts to 40,800 shares.

Series A: $1M investment at $5.00 per share = 200,000 shares.

Step 5: Calculate the New Cap Table

After all conversions:

Founder A: 500,000 shares (original)

Founder B: 500,000 shares (original)

Note 1 Investor: 73,558 shares (converted)

Note 2 Investor: 40,800 shares (converted)

Series A Investor: 200,000 shares

Option pool: 200,000 shares (unchanged)

Total shares: 1,514,358

Founder total: 1,000,000 shares ÷ 1,514,358 = 66% ownership

You've diluted from 83% (fully diluted pre-Series A) to 66% (fully diluted post-Series A). That's a 17 percentage point hit.

Step 6: Model Optimistic and Conservative Scenarios

Repeat Steps 4-5 for your $10M and $4M scenarios. This is where spreadsheets shine—use formulas to auto-calculate so you can change assumptions quickly.

$10M scenario: Share price $8.33, discounts apply differently, founders dilute less because the company is worth more.

$4M scenario: Share price $3.33, caps become more binding, founders dilute more because they're worth less.

You now have a range of likely outcomes. Most pro formas show a 15-35% founder dilution range across reasonable Series A scenarios.

Step 7: Stress-Test Assumptions

What if you raised another convertible note before Series A? Model it. What if an investor exercises a warrant? Model it. What if you've granted more options than expected? Model it.

The goal is to understand how sensitive your dilution is to changes in assumptions. If a single note change of $50K swings your founder ownership by 5 percentage points, you're in a fragile situation. If it swings by 0.5 points, you have room to maneuver.

Using Pro Formas in Negotiation

Pro formas are powerful negotiation tools. When an investor proposes a $2M cap, you can show them (and yourself) exactly what that means for founder dilution in realistic scenarios. Sometimes seeing the math makes a $2.5M cap seem reasonable in comparison.

You can also use pro formas to argue why a certain Series A valuation matters. If raising at $4M vs. $6M changes founder ownership by 10 points, that's a material difference worth negotiating hard for.

Tools for Building Pro Formas

Basic spreadsheet: Google Sheets or Excel work fine for simple models. Templates are available online.

Cap table software: Tools like Pulley, Captable.io, or Carta automate conversions and keep everything organized. They're worth the cost if you're managing multiple notes and employees.

Custom models: Some founders build detailed models in Python or R to run thousands of scenarios. Overkill for most, but useful if you have complex scenarios.

Common Pro Forma Mistakes

Forgetting interest accrual on convertible notes. That 2% annual interest isn't huge, but after 2-3 years it adds up.

Not modeling down cases. Your base case is optimistic by definition. Model a 30% down scenario—it happens to many startups.

Assuming no additional option grants. By Series A close, you've probably promised employees more options than your initial pool. Update your model.

Treating caps and discounts as separate. Model them together—whichever is better for the investor applies.

Key Takeaways

• Pro formas project cap table changes when convertible notes convert at Series A
• Build on your current cap table, apply note conversion math, then add Series A shares
• Model multiple Series A scenarios to understand dilution ranges
• Use pro formas to negotiate terms and stress-test assumptions
• Account for interest accrual, option grants, and both caps and discounts in your models

Frequently Asked Questions

Q: How often should I update my pro forma?
A: Every time something material changes: new convertible note, new employee options, or Series A timeline shifts.

Q: What if I don't know my Series A valuation yet?
A: That's normal. Model three scenarios (base, upside, downside) using your best estimates.

Q: Should I share my pro forma with investors?
A: Not necessarily with convertible note investors—it might highlight dilution. But definitely share with Series A investors as part of diligence.

Q: Can I use cap table software instead of building a spreadsheet?
A: Absolutely. Cap table software handles conversions automatically and is less error-prone.

Q: What if my cap table has SAFEs or other instruments?
A: Model each instrument's conversion terms separately, same as convertible notes.