Let’s do a numerical example ignoring any accrued interest:

1. You invest \$25k in a startup’s seed round using a convertible note with a \$5M cap

2. At the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of \$10M with a per share price of \$5.00

3. Your \$25k loan would convert into shares of Series A Preferred Stock at a price of \$2.50 per share (\$5M cap divided by \$10M pre-money valuation) which gives 10,000 shares of Series A Preferred Stock (\$25,000 divided by \$2.50/share); a new Series A investor would receive only 5000 shares of Series A Preferred Stock for \$25k

4. On paper, your 10,000 shares at \$5.00/share are worth \$50,000 which is an unrealized return of 100%

5. If the pre-money valuation were higher at \$20M, your \$25k note would convert at \$1.25/share (\$5M cap divided by \$20M) into 20,000 (\$25k divided by \$1.25) Series A shares worth \$100,000 for a paper unrealized return of 300%.

[Reproduced from original source here: https://bit.ly/2H4ri4V]