analyzing-convertible-instrument-terms

name	analyzing-convertible-instrument-terms
language	en
description	Evaluates SAFE, convertible note, and KISS structures with conversion mechanics, caps, discounts, and MFN provisions. Use when analyzing convertible instruments, comparing SAFE vs note terms, or modeling conversion scenarios.
tags	["analysis","venture-capital"]
metadata	{"author":"casemark","practice_areas":["Venture Capital","Seed/Series Investing","Startup Ecosystems"],"document_types":["Analysis Report"],"skill_modes":["Analysis"]}

Analyzing Convertible Instrument Terms

When To Use

• Reviewing a SAFE, convertible note, or KISS before a founder signs or an investor commits
• Comparing multiple convertible instruments across a cap table to assess aggregate dilution
• Modeling conversion outcomes at various pre-money valuations for an upcoming priced round
• Evaluating whether MFN provisions or pro-rata rights create conflicts across investor cohorts
• Advising on whether a valuation cap, discount rate, or hybrid structure best fits the deal context

Inputs To Gather

• Instrument documents: Full text of each SAFE, convertible note, or KISS (identify version — e.g., YC post-money SAFE 2018 vs. 2023 template)
• Instrument type and variant: Pre-money SAFE, post-money SAFE, convertible note (secured/unsecured), KISS (debt/equity variant)
• Economic terms: Valuation cap, discount rate (or both), interest rate and accrual method (notes only), maturity date (notes only)
• Key provisions: MFN clause scope, pro-rata rights, amendment/waiver thresholds, dissolution/liquidation waterfall priority
• Cap table context: Current outstanding shares, option pool size, any prior convertible instruments outstanding
• Anticipated round terms (if available): Expected pre-money valuation, round size, lead investor terms

Workflow

1. Classify each instrument

   • Identify instrument type (post-money SAFE, pre-money SAFE, convertible note, KISS debt, KISS equity)
   • Note the template version and any custom modifications from standard forms
   • Flag if the instrument is a non-standard or bespoke structure

2. Extract and tabulate economic terms

   • For each instrument, record: investment amount, valuation cap, discount rate, interest rate, maturity date, and MFN status
   • For convertible notes: confirm whether interest is simple or compound, accrual frequency, and whether interest converts or is repaid [VERIFY: confirm accrual terms in instrument]
   • Identify whether the cap is pre-money or post-money — this fundamentally changes dilution math

3. Analyze conversion mechanics

   • Cap conversion: Shares = Investment ÷ (Cap ÷ fully-diluted capitalization at conversion)
   • Discount conversion: Shares = Investment ÷ (Price per share × (1 − discount rate))
   • Hybrid (cap + discount): Investor receives the more favorable of cap-based or discount-based conversion
   • For post-money SAFEs: the investor's ownership percentage is fixed (Investment ÷ Cap), and dilution falls on founders and prior investors — not SAFE holders
   • For notes with accrued interest: calculate total converting principal + interest at expected conversion date

4. Model conversion scenarios

   • Run conversion at 2–3 representative pre-money valuations (e.g., $5M, $10M, $20M or as contextually appropriate)
   • Show resulting ownership percentages for each investor and for founders post-conversion
   • Identify the valuation at which the cap vs. discount "crossover" occurs (discount becomes more favorable than cap)
   • For stacked instruments: model aggregate dilution from all converting instruments simultaneously

5. Evaluate protective and structural provisions

   • MFN: Does it apply only to future SAFEs, or also to future convertible notes? Does it auto-trigger or require election? What is the notification mechanism?
   • Pro-rata rights: side letter or built into the instrument? Based on pre- or post-conversion ownership?
   • Amendment provisions: majority-in-interest threshold — by dollar amount or by holder count?
   • Dissolution/wind-down: payment priority relative to other instruments and equity holders [VERIFY: confirm liquidation waterfall ordering if multiple instrument types]

6. Identify risks and flag issues

   • Stacking risk: total SAFE/note overhang as a percentage of anticipated post-money valuation
   • MFN conflicts: later instruments with better terms triggering MFN for earlier holders, compounding dilution
   • Maturity risk (notes): what happens at maturity — auto-convert, founder repayment obligation, or default?
   • Shadow preferred: SAFEs converting into a separate series with different rights than the lead investor's preferred stock

Output

Structure the analysis report as follows:

• Instrument Summary Table: One row per instrument — type, date, amount, cap, discount, interest rate, maturity, MFN status
• Conversion Modeling: Scenario table showing shares issued and ownership percentages at 2–3 valuations
• Cap vs. Discount Crossover: The pre-money valuation at which each instrument's discount becomes more favorable than its cap
• Aggregate Dilution Impact: Total founder dilution from all converting instruments at the most likely round valuation
• Provision Comparison: Side-by-side comparison of MFN scope, pro-rata rights, amendment thresholds, and dissolution treatment
• Risk Flags: Bullet list of material risks (stacking, MFN cascades, maturity exposure, structural conflicts)
• Recommendations: Specific, actionable guidance — e.g., "Negotiate removal of MFN from Investor B's SAFE before closing Investor C" or "Cap total convertible overhang at 25% of anticipated post-money"

Quality Checks

• Confirm whether each instrument uses pre-money or post-money cap mechanics — misclassifying this produces materially wrong dilution figures
• Verify that conversion math uses the correct fully-diluted share count (including or excluding the option pool, depending on instrument terms) [VERIFY: check instrument definition of "Company Capitalization" or equivalent]
• Cross-check that MFN analysis accounts for all outstanding instruments, not just the one under review
• Ensure interest accrual calculations on notes match the stated accrual method and compounding frequency
• Validate that scenario modeling uses consistent assumptions across all instruments (same pre-money, same option pool treatment)
• Flag any instrument that deviates from standard YC SAFE / 500 Startups KISS templates and note the specific deviations