Case 014Term sheets and waterfallsCore

Notevik Payments raised a Rs 5 crore convertible note with interest, a discount and a valuation cap. When the Series A prices, how many shares does the noteholder receive?

The situation

Notevik Payments, which builds payment links for small exporters, raised Rs 5 crore through a convertible note. The note carries 10% simple interest a year, converts into the next priced round at a 20% discount to that round's price, and has a valuation cap of Rs 50 crore pre-money. The noteholder receives whichever gives it more shares.

Eighteen months later Notevik closes a Series A raising Rs 25 crore at Rs 400 a share, on a Rs 100 crore pre-money with 25 lakh shares outstanding before the note converts. The cap price is computed on the same 25 lakh shares.

Your task

How much does the note convert, at what price, into how many shares? What does the noteholder own after the round, and what is its paper multiple?

Quick check

Which price does the note convert at?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The note converts Rs 5.75 crore at the Rs 200 cap price into 2.875 lakh shares. Eighteen months of 10% simple interest adds Rs 0.75 crore to the Rs 5 crore principal. The cap price beats the Rs 320 discount price, so the cap decides. After the Rs 25 crore Series A the noteholder owns 8.42%, worth Rs 11.5 crore at the Series A price, 2.3x its money.

Step 1What exactly converts?

A convertible noteA loan to a startup that turns into shares at the next priced round instead of being repaid in cash, usually on better terms than the new investors get. is a loan that is repaid in shares. Like a deposit that earns interest until the day you use it as a down payment, the balance grows until the round arrives. Interest usually converts too, so the amount turning into shares is principal plus accrued interest, not the cheque. Ten per cent simple interest for eighteen months is 15% of Rs 5 crore, Rs 0.75 crore, so Rs 5.75 crore converts.

Step 2Which price applies: the discount or the cap?

Work out both and take the lower. The discount price is 80% of the Series A price: Rs 320. The cap price treats the company as if it were worth only Rs 50 crore before the round: Rs 50 crore divided by 25 lakh shares is Rs 200. The noteholder converts at Rs 200, because a lower price buys more shares, and the cap and discount are alternatives, never applied together. The cap matters here because the round priced the company at twice the cap; had the Series A come in at Rs 60 crore pre-money, the discount would have won.

Notevik's note grows from Rs 5 crore to Rs 5.75 crore over eighteen months and converts at the Rs 200 cap price into 2.875 lakh shares, against 1.797 lakh at the Rs 320 discount price and 1.4375 lakh at the full Rs 400.

The relationship

\text{Shares} = \frac{5 \times (1 + 0.10 \times 1.5)}{\min(0.8 \times 400,\; 50\text{ cr} / 25\text{ lakh})} = \frac{5.75\text{ cr}}{200} = 2.875 \text{ lakh}

0.10 x 1.5	18 months of 10% simple interest
0.8 x 400	the discount price, Rs 320
50 cr / 25 lakh	the cap price, Rs 200

What it says in wordsDivide what the note has grown to by the lower of the discount price and the cap price.

Step 3What does everyone own after the round?

The Series A investors pay Rs 25 crore at Rs 400, buying 6.25 lakh shares. With the founders' 25 lakh and the noteholder's 2.875 lakh, there are 34.125 lakh shares. The noteholder owns 8.42%, the Series A 18.32% and the existing holders 73.26%. At Rs 400 a share the noteholder's stake is worth Rs 11.5 crore, 2.3x the Rs 5 crore it lent, on the day it converts.

Holder	Shares, lakh	Ownership	Value at Rs 400, Rs cr
Existing holders	25.000	73.26%	100.0
Noteholder	2.875	8.42%	11.5
Series A	6.250	18.32%	25.0
Total	34.125	100.00%	136.5

After the Series A there are 34.125 lakh shares; the noteholder's 2.875 lakh are 8.42% of the company and worth Rs 11.5 crore at the Series A price.

Step 4Who pays for the cap?

Here the note's extra shares sit on top of a Rs 100 crore pre-money, so the Series A investor and the founders share the dilution. In many real term sheets the new investor insists the converting shares are counted inside the pre-money, which lowers the price per share and pushes the whole cost of the cap onto the founders. Always ask whose pre-money the note converts in, because that decides who pays for the cap. Indian rules also limit which companies may issue convertible notes, to whom and on what terms; confirm the current conditions before structuring one.

Where candidates lose it

The usual loss is converting only the Rs 5 crore principal and forgetting the interest. Eighteen months at 10% is another Rs 0.75 crore, which buys another 37,500 shares at the cap price.

The second is applying both protections at once, 80% of the cap price, and converting at Rs 160. The holder gets the better of the two, not the product of both.

What the interviewer asks next

The Series A investor insists the note shares are inside the Rs 100 crore pre-money. What is the new price per share?
At what Series A pre-money does the discount start to beat the cap?
Why do founders prefer a cap on a post-money basis, and why do investors resist it?

Company names and figures are illustrative.