Let’s do numerical example ignoring any accrued interest:

1. You invest \$25k in a startup’s seed round using a convertible note with a \$5M cap, 20% discount

2. If, 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 IF we apply the discount, the price per share would be \$4.00/share (\$5.00 times (1 minus 20%)) IF we apply the cap, the price per share would be \$2.50/share (\$5.00 times (\$5M cap divided by \$10M pre-money valuation)) THUS the cap would apply and the note would convert at \$2.50/share which gives 10,000 shares of Series A Preferred Stock (\$25,000 divided by \$2.50/share). On paper, your 10,000 shares at \$5.00/share are worth \$50,000 which is an unrealized return of 100%.

3. If, at the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of \$6M with a per share price of \$5.00 IF we apply the discount, the price per share would be \$4.00/share (\$5.00 times (1 minus 20%)) IF we apply the cap, the price per share would be \$4.1667/share (\$5.00 times (\$5M cap divided by \$6M pre-money valuation)) THUS the discount would apply and the note would convert at \$4.00/share which gives 6,250 shares of Series A Preferred Stock (\$25,000 divided by \$4.00/share). On paper, your 6,250 shares at \$5.00/share are worth \$31,250 which is an unrealized return of 25%

[Reproduced from original source here: https://bit.ly/1CLV2gV]