Cap table & dilution
Conversion mechanics
The specific rules that turn your SAFE or note into shares — which financings trigger it, at what price, into which class, and what happens if no qualifying round ever arrives.
In plain English
Every convertible instrument contains a small machine, and the machine has four moving parts. The trigger: which events cause conversion, usually a "qualified financing" above a stated size. The price: cap, discount, or the better of the two. The class: which shares you receive, which may be the new preferred class or a shadow class with reduced rights. The fallback: what happens on an acquisition, at maturity, or if the trigger never fires.
The qualified financing definition is the part most often skimmed and most often decisive. If it requires a round of at least $3m and the company raises $2.5m, your instrument does not convert. It sits outstanding while new shareholders arrive above you, and it converts later at terms set by circumstances you did not anticipate.
The shadow-class question is subtler. When SAFEs at a $5m cap convert into a round priced at $15m, the converting investors receive more shares per dollar than the new investors. Some documents give them a shadow series — the same economics but a liquidation preference equal to what they actually paid rather than the round price. This is fair and standard; it also means your preference is smaller than the round price implies.
Finally, conversion is a taxable event in some jurisdictions and not others, and it can affect holding-period clocks that matter for capital gains treatment. Worth a question to your own adviser rather than the company's.
What it means for your cheque
Read the conversion clause with more attention than the cap. The cap determines what you get in the expected case; the conversion mechanics determine what happens in every other case, and every other case collectively is more likely than the expected one.
The three questions to answer before signing: what happens if the company is acquired before conversion, what happens if it raises less than the qualified financing threshold, and what happens if it never raises again. Good documents answer all three explicitly. Many do not answer any of them.
Do the arithmetic
A conversion that does not trigger
You hold a $25,000 SAFE with a $6m cap. The qualified financing threshold is $3,000,000. The company raises $2,200,000 from a strategic investor at a $14m pre-money.
| Round size | $2,200,000 |
|---|---|
| Qualified financing threshold | $3,000,000 |
| Does your SAFE convert? | No — the round does not qualify |
| Your position after the round | still an unconverted SAFE, now behind $2.2m of new preferred |
| If the company is then sold for $40m | you convert at the $6m cap under the change-of-control clause, if it has one |
| If it has no change-of-control clause | you may be entitled only to your $25,000 back |
A threshold you never read decided whether you owned 0.4% of a $40m sale or received your money back with no gain. The cap was irrelevant to the outcome.
At the table
What to negotiate
- Read the qualified financing definition and push the threshold down, or remove it, so that any equity financing triggers conversion.
- Confirm the change-of-control provision gives you the greater of your money back and conversion at the cap.
- Ask which share class you convert into and whether a shadow series applies.
- For notes, confirm what happens at maturity if no qualifying round has occurred — conversion at a stated valuation beats an open-ended extension.
- Ask whether conversion is automatic or requires an election, and if the latter, what notice you receive.
Conversion mechanics: common questions
What is a qualified financing?
Do I get the same shares as the new investors when I convert?
What if the company never raises another round?
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