Let’s do a simple numerical example ignoring any accrued interest:
You invest $25k in a startup’s seed round using a convertible note with a 20% discount
At the Series A, the startup raises money from a venture capital firm that pays $5.00 per share of Series A Preferred Stock
Your $25k loan would convert into shares of Series A Preferred Stock at a price of $4.00 per share ($5.00 times (1 minus 20%)) which gives 6250 shares of Series A Preferred Stock ($25,000 divided by $4.00/share); a new Series A investor would receive only 5000 shares of Series A Preferred Stock for $25k
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/2PTW2Zw]