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You are here: Home / Convertible note / What is the economic difference between a conversion discount and warrant coverage for a convertible note?

What is the economic difference between a conversion discount and warrant coverage for a convertible note?

June 22, 2007 By Yokum 20 Comments

The advantages of a conversion discount versus warrant coverage depend on math and modeling.

In the example of 20% conversion discount versus 25% warrant coverage, the formulas below apply.

The value of investment with the 20% conversion discount = {[Investment amount] / [0.8 * Series A price]} * [exit value of Series A]

In other words, the above formula represents: how many shares of Series A do you get after the discount * the exit value of Series A per share.

The value of the investment with 25% warrant coverage = {[Investment amount / Series A price] * [0.25] * [exit value of Series A – Series A warrant exercise price]} + {[Investment amount / Series A price] * [exit value of Series A]}

In other words, the above formula represents: the exit value of the Series A warrant shares (taking into account the warrant exercise price) + the exit value of the Series A shares issued upon conversion of the note.

If Series A price (and Series A warrant exercise price) = $1.00, then the 20% conversion discount will always be slightly more valuable than 25% warrant coverage. (This is simple algebra to solve for the above equation.)

There is a reason why I think corporate attorneys need strong math skills. I hope someone will check the above math and concur or correct me.

Filed Under: Convertible note

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